Foreign Investment and Domestic Development: Multinationals and the State 9781626373471

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Foreign Investment & Domestic Development

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F OREIGN I NVESTMENT & D OMESTIC D EVELOPMENT Multinationals and the State

Jenny Rebecca Kehl

b o u l d e r l o n d o n

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Published in the United States of America in 2009 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 www.rienner.com and in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 2009 by Lynne Rienner Publishers, Inc. All rights reserved ISBN: 978-1-58826-633-0 Library of Congress Cataloging-in-Publication Data A Cataloging-in-Publication record for this book is available from the Library of Congress. British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library. Printed and bound in the United States of America The paper used in this publication meets the requirements of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1992. 5 4 3 2 1

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Contents

List of Illustrations

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1 Introduction: The Political Economy of Development 2 The Politics of Profit: Foreign Investment as a Development Strategy 3 Roadblocks: Ineffective Bureaucracies in Kenya 4 Corruption: Impeding Pioneer Industries in Nigeria 5 Growing Pains: Securing the Benefits of High Tech Investment in India 6 Joint Ventures: Developing a Business Class in Malaysia 7 Adelante: Government Commitments to Reduce Investment Risk in Chile 8 After NAFTA: Attracting Multinationals with Free Enterprise Zones in Mexico 9 Looking Forward: The Trajectory of Foreign Investment and Domestic Development Appendix: Research Notes Bibliography Index About the Book

1 11 47 59 71 85 97 105 117 133 143 155 163

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Illustrations

Table 2.1

The Interaction Effects of Political Institutions, Political Economy, Foreign Investment, and Economic Growth

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Figures 2.1 2.2 9.1 9.2

Worldwide Increase in Foreign Direct and Portfolio Investment Total Foreign Investment in World Regions, 1970–2000 Comparative Levels of Democracy and Government Effectiveness Comparative Levels of Direct and Indirect Benefits from Foreign Investment

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16 17 126 127

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1 Introduction: The Political Economy of Development

THE DEVELOPING WORLD RELIES ON GLOBAL markets to stimulate

growth and generate wealth. Yet, in this time of great global opulence, trillions of dollars flow through the developing world without altering its reality of poverty and scarcity. At the turn of the century, the world’s fifty largest foreign investors in the developing world held $1.8 trillion in foreign assets and $2.1 trillion in sales.1 Amartya Sen, Nobel laureate in economic sciences, contrasts this unprecedented amount of wealth in the international economy with the “remarkable deprivation, destitution and oppression” observed in most of the world.2 There is a growing discrepancy between the substantial foreign investment in the developing world and the sparse resources available for domestic development. The global market alone has failed to reverse this trend. However, the size of the global economy is expected to quadruple in the next fifty years, with the majority of the growth in foreign direct investment (FDI). This growth has the potential to increase the financial and capital resources available to promote development in poor countries. The expansion of FDI offers developing countries the opportunity to increase their integration into the global market and to develop investment patterns that maximize their possibilities for economic growth. In this book I examine the crucial relationship between foreign direct investment and domestic economic development. Foreign direct investment can be an asset to developing countries by providing employment, capital, revenue, trade, and technology. Most underdeveloped countries, however, lack the institutional capacity to negotiate mutually beneficial investment arrangements with multinational corporations. Weak political institutions and perverse economic policies make developing countries easily exploitable. Nevertheless, as this study 1

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demonstrates, developing countries can in fact gain greater benefits from hosting foreign investment, without deterring future investment. The essential strategies for gaining greater benefits from foreign investment are political, not economic. Political institutions mediate the conflict of interest and the disparity of power between multinational corporations and host governments in order to maximize benefits and minimize externalities. In the chapters that follow, I provide crossnational evidence that domestic benefits from foreign investment are contingent on government capacity, democratic accountability, regulatory standardization, and development policies that maximize freedom of production and consumption. I also compare the distinct investment arrangements of General Motors Corporation, one of the world’s largest foreign direct investors, in Mexico, India, Nigeria, Kenya, Chile, and Malaysia. This innovative multimethod approach exposes the negotiation strategies of host governments and General Motors, and provides a much-needed assessment of the outcomes of investment arrangements for developing countries and multinational corporations. Not all developing countries have been able to benefit from the promise and prosperity of foreign investment. Poor countries cannot rely on the altruistic intentions of foreign investors to promote domestic development. Most multinational corporations are more highly organized and have more money than the countries in which they invest. This gives them leverage to negotiate lucrative, and often exploitative, deals with fledgling governments in poor countries. There is an important ongoing narrative about how foreign investment leads to exploitation. But that is not the narrative of this research. My purpose is to demonstrate how developing countries can manage foreign investment to promote domestic development. The benefits and externalities of hosting FDI are largely a function of how well governments negotiate initial investment arrangements. Accordingly, I address the following questions: What specific strategies are successful in negotiating mutually beneficial investment arrangements between countries and corporations with asymmetrical bargaining power? Are there discernible differences in domestic political institutions and economic policies that generate distinct patterns of foreign direct investment? What determines the success or failure of developing countries to utilize foreign investment to promote domestic development? Previous research has focused almost exclusively on how to attract foreign investment. This study focuses on how to utilize it.

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The Role of Political Institutions Political institutions provide incentives and impose constraints on foreign investment. Governments rely on institutions to resolve political problems, coordinate economic activities, and implement strategies to promote development. In the case of foreign investment, the capacity of developing countries to negotiate mutually beneficial investment agreements is contingent on the ability of political institutions to achieve specified goals.3 Political institutions must be able to manage resources, react to political and economic challenges, predict and prevent crises, and achieve policy results. The World Bank’s Global Development Finance Report suggests that good policies and good governance, along with strong institutions, are critical to using private foreign investment inflows productively. 4 When governments decide to host foreign investment as part of an economic development strategy, political institutions often determine the success or failure to maximize domestic benefits and minimize negative externalities. Political institutions moderate competing interests, mediate asymmetrical power, develop codes of conduct, and specify the rights and responsibilities of foreign corporations and host governments. Recognizing the explanatory value of political institutions challenges the alternative explanation of economic determinism. The relationship between foreign direct investment and domestic development cannot be explained entirely by economic variables. Chapter 2 elaborates on the alternative economic explanations. However, as Frances Hagopian and Samuel Huntington argue, “economic forces are indeterminant [sic]; their influence on outcomes must be filtered through political institutions.”5 The political institutional framework suggests that institutions are central to good economic governance. Governments develop institutions to raise revenue and stimulate economic growth in response to political and economic interests.6 To satisfy these interests, institutions have become “larger, considerably more complex and resourceful, and prima facie more important,”7 particularly in developing countries. There is, however, wide variation in the capacity of governments to establish effective institutions to meet political demands and economic needs in the developing world. In this study I analyze several indicative political variables—including regime type, accountability, transparency, political stability (political risk), regulation of production practices, performance requirements, and government effectiveness—in order to determine what specific institutional

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arrangements are successful at achieving good economic governance in developing countries.

The Role of Political Economy The political economy approach argues that development is driven by a combination of market mechanisms and government decisions. On a spectrum from laissez-faire to command economies, governments often make deliberate political decisions for economic reasons.8 Government policies may have calculated effects on the market through rules of commerce, fiscal policy, regulation, taxation, expenditure, production, and consumption. I examine these economic indicators in Chapter 2, in accordance with the new institutional economics theory established by Douglass North, Ronald Coase, and Robert Fogel.9 This theory suggests that it is the underlying institutional framework that determines the success or failure of efforts to establish market-oriented strategies that promote economic growth. In the case of using foreign investment as part of a development strategy, governments may choose to intervene in production or consumption in order to maximize the profitability of the investment. The liberal theory of political economy suggests that governments must determine their level of intervention in the economy based on the consequences for the market. Pure laissez-faire liberalism advocates a minimal level of government intervention in the economy. However, most political economy theories of development acknowledge that the state is clearly a key actor for countries in the developing stages.10 The political economy framework suggests that governments intervene, minimally, in market systems to provide an environment that is conducive to economic growth, to arbitrate between government policy goals and those of individuals and firms, 11 and to compensate those adversely affected.12 Political economy theory parallels political institutional theory regarding the “coordination” of market forces. However, political economy emphasizes the importance of factors such as market access, market size, trade practices, taxation, and the level of intervention in market forces, while the political institutional approach focuses on variables such as institutional accountability, political stability, government capacity, and policy implementation. The political economy framework advocates for economic neoliberalism as the guiding principle for coordinating market forces. Although neoliberalism has been

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hotly debated at the theoretical level, the evidence in support of free trade is almost undisputed in the industrialized countries. The picture in the developing countries, however, is quite different. As political economist A. F. K. Organski argues, the poorer the country, the more important are political factors.13

A Mixed Reception for Foreign Investment Foreign investors receive a wide variety of receptions in developing countries. India is an emerging economy that welcomes foreign investors into government-financed High Tech City buildings that are designed to impress modern multinational corporations. These buildings have backup energy sources to compensate for the regular power outages in India, as well as emergency flight plans to transport employees to the nearest High Tech City if their computer systems collapse. The facilities allow foreign investors to conduct business without disruptions in energy supplies or computer communications, which is a luxury that most domestic businesses do not have. Foreign companies have been highly successful in High Tech City locations in India. For example, General Motors has orchestrated the Chevrolet Indian Revolution, “a love affair with the Chevy”14 that has generated hundreds of millions in revenue. This illustrates a warm reception for foreign investors from the Indian government and consumers. But not everyone shares the love affair with foreign investors. The train bombings in Mumbai in 2006 specifically targeted business commuters on their way to work in modern High Tech City locations for foreign firms such as IBM, Nestlé, Nokia, and General Electric. Malaysia has developed technology corridors, similar to India’s High Tech City buildings, and Mexico has designated maquiladora zones as free enterprise zones to welcome foreign investors. Multinational corporations often receive tax breaks, corporate subsidies, labor concessions, toxic-emission exemptions, and other incentives to conduct business in technology corridors and maquiladora zones. However, political officials and business leaders in both countries have accused foreign investors of creating expensive externalities and failing to honor their initial contracts. In Mexico the outcomes of these disputes are determined largely by the North American Free Trade Agreement, which favors the foreign firms. In Malaysia the central bureaucracy normally governs over foreign investment, but the bureaucracy’s power is limited

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in free enterprise zones. Similar arrangements exist in free enterprise zones worldwide to maximize the freedom of production and consumption for multinational corporations. Even with free enterprise zones, African countries have had trouble marketing their economies as destinations for FDI. They have been scrambling to receive foreign investors and have undercut each other in a race to the bottom—promising to minimize benefits for the host country in order to maximize profits for the foreign investors. Many African countries agree to forego tax revenue; allow profits to be repatriated rather than reinvested; give away resource rights, mining rights, drilling rights, and valuable raw materials; and absorb the cost of negative externalities in order to attract foreign investors. Despite these concessions, there are sectors that gain benefits from hosting foreign investment, such as oil in Nigeria, agriculture in Kenya, and manufacturing in South Africa. Although the relationship between foreign investment and domestic development is tenuous throughout the continent, African countries continue to welcome foreign investors because they need the capital, employment, technology, and revenue that those investors generate. It is unrealistic and counterproductive to discourage African countries from receiving foreign investment as part of a development strategy. It is more productive to examine a variety of strategies that poor countries can use to improve their investment arrangements by maximizing benefits and minimizing negative externalities.

Organization of the Book This book is designed to demonstrate how developing countries can manage foreign investment to promote domestic economic growth. “The Politics of Profit: Foreign Investment as a Development Strategy,” Chapter 2, examines the political institutions and economic policies that affect the benefits and externalities from hosting foreign direct investment. Here I examine FDI arrangements using a cross-national analysis of 147 developing countries across 35 years (1971–2006). I test the significance of three competing explanations—political institutional, political economy, and a synergistic model—and examine globalization, diffusion, and the learning process across states. The dynamics of diffusion and the causal mechanisms of change are illustrated in the case studies of Kenya, Nigeria, India, Malaysia, Chile, and Mexico. Chapter 3, “Road Blocks: Ineffective Bureaucracies in Kenya,” and Chapter 4, “Corruption: Impeding Pioneer Industries in Nigeria,” analyze the consequences of weak political institutions and inconsistent

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economic reforms in the African region. The case of Kenya demonstrates how ineffective bureaucracy and political instability can result in divestment, while the Nigerian case exposes the debilitating effects of corruption. Chapter 5, “Growing Pains: Securing the Benefits of High Tech Investment in India,” and Chapter 6, “Joint Ventures: Developing a Business Class in Malaysia,” demonstrate how institutional capacity has expedited the process of foreign investment and domestic development. India’s arrangements with General Motors reveal successful strategies for attracting and utilizing foreign investment to achieve rapid economic growth, despite contradictions between a large labor pool and a small tax base, as well as hidden costs of increasing inequality. The case of Malaysia’s contracts with General Motors illustrates the impact of centralized government on investment arrangements, which has allowed Malaysia to enforce requirements on employment and technology transfer. Chapter 7, “Adelante: Government Commitments to Reduce Investment Risk in Chile,” and Chapter 8, “After NAFTA: Attracting Multinationals with Free Enterprise Zones in Mexico,” focus on the importance of reducing political risk and the dynamics of foreign direct investment in Latin America. They also correct several of the inaccurate myths about what foreign investors consider to be compelling incentives and constraints. Mexico’s arrangements with General Motors also highlight the effects of superstructures on the relationship between foreign investment and domestic development, showing how the North American Free Trade Agreement has determined most of the interregional incentives and constraints for foreign investment. The concluding chapter of the book, “Looking Forward: The Trajectory of Foreign Investment and Domestic Development,” provides a synopsis of the research and offers projections about the modernization of investment negotiations and development strategies. The research findings demonstrate that the quality of the investment environment, rather than the quantity of investment, determines profitability for both investors and host countries. The findings also highlight the discernible differences in political institutions that result in distinct patterns of investment.

Notes Thank you to Rutgers University–Camden, faculty colleagues I have thanked in person, and the Office of Sponsored Research and Programs for the support and resources to complete this project. Special thanks also to James Scarritt for his insight and expertise.

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1. United Nations Conference on Trade and Development. World Investment Report. 2003. FDI Policies for Development: National and International Perspectives. New York: United Nations. 2. Amartya Sen. 1999. Development as Freedom. New York: Random House, p. xi. Sen was Nobel laureate in economic sciences in 1998. 3. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview Press; David Leblang. 1997. “Political Capacity and Economic Growth.” In Political Capacity and Economic Behavior, edited by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview Press. 4. World Bank. 2004. Global Development Finance Report 2004. Washington, DC: World Bank Group, pp. 64–65. 5. Frances Hagopian. 2000. “Political Development, Revisited,” Comparative Political Studies 33: 893; Samuel Huntington. 1968. Political Order in Changing Societies. New Haven, CT: Yale University Press. 6. Margaret Levi. 1997. “A Model, a Method, and a Map: Rational Choice in Comparative and Historical Analysis.” In Comparative Politics: Rationality, Culture, and Structure, edited by Mark Lichbach and Alan Zuckerman. Cambridge: Cambridge University Press; Margaret Levi, 1988, Of Rule and Revenue. Berkeley: University of California Press; Avner Greif, Paul Milgrom, and Barbara Weingast. 1994. “Coordination, Commitment, and Enforcement: The Case of the Merchant Guild,” Journal of Political Economy 102: 745–776. 7. James March and Johan Olson. 1984. “The New Institutionalism: Organized Factors in Political Life.” American Political Science Review 78: 734. 8. Kenneth Arrow. 1951. Social Choice and Individual Values. New Haven, CT: Yale University Press; Anthony Downs. 1957a. “Causes and Effects of Rational Voter Abstention.” In An Economic Theory of Democracy. New York: Harper; Anthony Downs. 1957b. An Economic Theory of Democracy. New York: Harper; William Riker. 1982. Liberalism Against Populism: A Confrontation Between the Theory of Democracy and the Theory of Social Choice. San Francisco: W. H. Freeman and Mancur Olson. 1971. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press; Douglass North. 1981. Structure and Change in Economic History. New York: Norton; Douglass North. 1990. Institutions, Institutional Change, and Economic Performance. New York: Cambridge University Press; Margaret Levi. 1988. Of Rule and Revenue. Berkeley: University of California Press. 9. Douglass North. 1999. Understanding the Process of Economic Change. London: Institute of Economic Affairs and the London Business School. Douglass North and Robert Fogel are 1993 Nobel laureates in economic sciences; Ronald Coase, 1991 Nobel laureate in economic sciences. 10. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview, p. 15. 11. Ibid. 12. Peter Katzenstein. 1985. Small States in World Markets. Ithaca, NY: Cornell University Press.

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13. A. F. K. Organski. 1997. “Theoretical Link of Political Capacity to Development.” Pp. 47–66 in Political Capacity and Economic Behavior, edited by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview. 14. Sandeep Raj Singh. January 29, 2007. “General Motors India on a Roll,” Company News, New Delhi, General Motors India, p. 5.

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2 The Politics of Profit: Foreign Investment as a Development Strategy

INTERNATIONAL INVESTMENT CAN SERVE AS AN engine for growth and economic development in the Third World by increasing global integration, employment, technology, skills training, infrastructure development, and revenue from taxation. The world’s poorest countries lack sufficient amounts of these assets and thus cannot reverse chronic underdevelopment. Although it is not a panacea, foreign investment may provide a modicum of the capital and technology necessary to spark domestic economic growth and development. The modern concept of development is both ambiguous and ambitious. Development incorporates the broad processes of democratization, marketization, and globalization. Scholars who study development are charged with the complex, and often contentious, task of identifying the goals and strategies for development. As Samuel Huntington explains, studies of development focus on sequences in the choice of development goals, institutional structures for reconciling development goals, and governmental strategies to promote the simultaneous achievement of development goals.1 The goals of development include a wide range of political and economic indicators such as legitimate and effective government, economic growth, industrialization, international trade, improved standard of living, public health and safety, education, and poverty reduction. It is difficult to achieve academic consensus on the exact goals of development, but it is even more problematic to try to achieve agreement on the most effective strategies to expedite growth and foster development. The role of foreign investment in development is becoming increasingly important as the amount of international assets increases exponentially and the wealth disparity between rich and poor nations widens.

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Foreign investment accounts for $1.8 trillion of capital assets in the developing world, more than the total domestic capital assets of all developing countries combined.2 This indicates an immense discrepancy between the potential and reality of foreign investment as a stimulus to economic growth in the developing world. For this reason, the scholarly debate centers around whether foreign investment helps or hinders economic development. The most highly contentious aspect of this debate is whether the intent of foreign investment is exploitative and extractive or contributory and facilitative of economic growth. Scholars disagree fundamentally about the balance of costs and benefits of foreign investment. Advocates of using foreign investment as an economic development strategy argue that it promotes production and consumption, introduces new technologies, and thus stimulates economic growth. The specific benefits of foreign investment include the ability to increase the volume of world trade, increase investment capital, finance loans, lobby for free trade, underwrite research and development, introduce and dispense technology, use comparative advantage to reduce costs of goods, generate employment, train workers, disseminate marketing and mass-advertising methods, increase access to international markets, promote national revenue and growth, and accelerate global integration of the economy. Foreign aid, such as grants and loans, has also provided a significant amount of funding for these development projects. However, the amount of foreign grants and loans has been decreasing in absolute terms. This trend continues downward based on government and international finance organization audit reports regarding the misuse of aid and default on loans. The decrease in foreign aid has turned the developing world toward foreign investment as an additional source of economic growth. Opponents of using foreign investment to foster domestic development argue that it is a form of exploitation and extraction that curtails or distorts economic growth.3 The distortion of the economy is often a reflection of the divergence of interests between domestic governments and foreign investors. Foreign investors make demands that may contradict the development goals of host countries. The specific negative effects of foreign investment include monopolies that reduce domestic competition, deprive local industries of investment capital, export profits to home countries, increase dependence through debt and external donor decisions, monopolize production, control distribution, inhibit the growth of domestic infant industries, create cartels, exploit labor, monopolize raw materials, limit international supply of raw materials,

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and limit domestic control over resources. Foreign investment has also been known to widen the gap between rich and poor on the national and international levels, increase the wealth of local elites at the expense of the poor, support and rationalize repressive regimes, erode traditional cultural values and replace them with homogenized “world culture” based on consumer-oriented values, and challenge the autonomy of domestic governments.

The Divergent Interests of Foreign Investors and Host Governments Foreign investment exemplifies the paradox of dependence on foreign finance to promote domestic development. There is a clear divergence of interests between foreign investors and domestic governments. The primary interests of foreign investors are to increase profitability, competitiveness, and access to international markets. The primary interest of developing countries is to foster domestic economic growth. The dilemma is best articulated in the World Investment Report by the United Nations Conference on Trade and Development (UNCTAD), which specifically discusses the relationship between domestic development and foreign direct investment: Governments need to counter two sets of market failures. The first arises from information or coordination failures in the investment process, which can lead a country to attract insufficient FDI. The second arises when private interests of investors diverge from the economic interests of host countries. This can lead FDI to have a negative effect on development, or . . . benefits that are not sustainable over time.4

Considering this divergence of interests, how can foreign investment be used as a strategy to promote domestic development? The divergence of the private interests of foreign investors from the domestic interests of host governments can be moderated or mediated to avoid the negative effect predicted by the World Investment Report. The moderation of interests is possible because foreign investors and host governments have a few basic mutual interests such as increasing production, consumption, trade, and competitiveness in the global market. The primary goal of foreign investors, however, is not to serve as philanthropic financiers of development in poor countries. Their objective is to maximize profits by decreasing the cost of labor, raw materials, industri-

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al waste, and other externalities. Despite the proverbial bottom line, negotiations between investors and hosts can establish mutually beneficial investment arrangements. Developing countries, however, exhibit wide variation in the capacity to execute such negotiations. The process of bargaining illustrates the problems of divergent interests and asymmetric power between foreign and domestic forces. The bargaining power thesis argues that the actors’ relative capacity and leverage in the negotiation process determines the balance of benefits and concessions in using foreign investment as a development strategy. The central foundations of bargaining theory were established as early as 1945 by Albert Hirschman in his book National Power and the Structure of Foreign Trade, which argues that outcomes are contingent on the level of asymmetry of power.5 Interest in this work was revived when Robert Keohane and Joseph Nye published Power and Interdependence.6 The current literature on bargaining theory focuses on vertically integrated investments that are characterized by risk, sunk costs, government learning, and rivalry among dynastic or oligopolistic conglomerates.7 The divergence of interests and the outcomes of negotiations are a function of relative power.8 There is also a time dimension to negotiating the benefits and concessions of foreign investment. The original bargain may need to be renegotiated over time if the power structure is altered or the political and economic conditions change substantially, making the original bargain obsolete. An optimistic view believes bargains made as a result of unequal power will ultimately need to be renegotiated. A more realistic perspective suggests bargains may need to be renegotiated as a result of structural change over time. The initial concession agreement may not be satisfactory to retain foreign investment or domestic support for hosting foreign investment. The large variation in governments’ capacity to negotiate can be explained in part by differences in political institutions and political economy, which are indicative of bargaining power. Political institutions impose structure on negotiations and investment arrangements. They provide incentives and constraints to cooperate or defect. Democratic accountability, for example, serves as a mechanism through which constituents require governments to procure benefits from hosting foreign investment, minimize corruption, and promote domestic economic growth. Government officials make deliberate decisions about economic policies such as taxation, trade, government intervention, access to markets, and economic liberalization that directly affect the success or failure of foreign investment to expedite economic growth.

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Contrary to most existing theories, this research does not suggest that money flow is the bottom line. Inflow is not the determinant factor of development. Billions of dollars flow through the developing world every year, and the amount has been increasing logarithmically for decades. Yet over 100 countries are poorer now than they were thirty years ago.9 It is still important to ask what attracts foreign investment, but the question no longer stands alone. The more profound and prescriptive question is this: how can developing countries succeed in utilizing foreign investment to promote domestic growth? The opportunity is increasing as the overall size of the global economy increases. The size of the global economy is expected to quadruple in the next fifty years, with an estimated worldwide gross domestic product of $140 trillion.10 The substantial expansion of the global economy offers developing countries the opportunity to increase their level of integration into global financial flows and to develop investment patterns that maximize their potential for economic growth. The greatest promise for increasing global integration and economic growth lies in the acquisition and effective utilization of foreign investment. However, as evidenced in the past fifty years, the inclusion of developing countries in the promise and prosperity of FDI is not automatic. Small and weak economies are often pummeled by the momentum, competitiveness, and volatility of the global economy. In contrast, a more optimistic view is justified by the fact that twenty-four developing countries have increased their integration into the world economy over the past three decades. These countries have achieved an average economic growth rate of 5 percent, compared with an average growth rate of 2 percent in wealthy industrialized countries.11 Despite the apparent contradictions between success stories and failed experiments, there are distinct empirical trends in foreign investment.

Trends in Foreign Investment The overall amount of foreign investment is increasing worldwide with five indicative trends. The first, and most apparent, trend is the dramatic increase of both foreign direct investment and portfolio investment during the past thirty years. However, there is wide variation in the amount of foreign investment in developing countries. The lowest levels of foreign investment are a few million dollars, such as in the Highly Indebted Poor Countries (HIPC), mostly in Africa and South Asia. In comparison, the highest levels of foreign investment in developing regions total tens of billions of dollars, such as in Brazil, Russia, India, and China (BRIC

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countries). In contrast to developing regions, investment in well-developed regions is more predictable, exhibiting only minimal variation. A second notable trend is the relatively consistent growth pattern of foreign direct investment in contrast to the volatile pattern of portfolio investment. Figure 2.1 compares the temporal increase of foreign direct investment and portfolio investment worldwide during 1970–2000. A third important trend is the substantial increase of foreign investment in Asia during the 1980s and 1990s. This includes the sharp decline corresponding to the East Asian Financial Crisis in 1997 and the ongoing economic recovery. The fourth trend is the rise of investment in central Europe and Russia in the early 1990s after the fall of the Soviet Union. The final distinctive trend is the comparative lack of foreign investment in sub-Saharan Africa. The overall level of investment in sub-Saharan Africa is low and stagnant relative to other developing regions. Figure 2.2 shows the variation of the total amount of foreign investment in developing regions.

Figure 2.1

Worldwide Increase in Foreign Direct and Portfolio Investment, 1970–2000 Foreign Investment

7000 Foreign Direct Investment Foreign Portfolio Investment 6000

5000 Dollars in US Billions

4000

3000

2000

1000

0 19 71 19 72 19 73 19 74 19 75 19 76 19 77 19 78 19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99

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Source: Data complied from World Investment Reports, United Nations Conference on Trade and Development (UNCTAD).

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Total Foreign Investment in World Regions, 1970–2000

60 Sub-Saharan Africa Middle East

50

South East Asia East and Central Europe

40 Dollars in Billions

Latin America

30

20

10

0 19 71 19 72 19 73 19 74 19 75 19 76 19 77 19 78 19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98

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Year

Source: Data complied from World Investment Reports, United Nations Conference on Trade and Development (UNCTAD).

Beyond Trends Pooled Cross-Sectional Time Series (CSTS) regression analysis is used to test the empirical relationships among government institutions, political economy, foreign investment, and domestic economic growth. Time Series analysis is the most appropriate methodology to test the proposed hypotheses for two reasons. First, a large-n empirical model can more fully specify the relevant variables, identify the significant positive or negative effects, analyze spatial and temporal variations, and test for interaction effects among the variables. Second, correlation can be determined, and causality can be inferred, if changes in the independent variables precede changes in the dependent variable. Cross-Sectional, or cross-national, Time-Series regression tests data for 147 developing countries over thirty-five years (1971–2006). In addition to constraints on the availability of data before 1970, there are statistical and substantive reasons for selecting this thirty-five-year time span. Statistically, the length of time provides enough time points to resolve potential problems of heteroskedasticity and degrees of freedom

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in the empirical analysis, as explained in more detail in the following section. Substantively, the greatest expansion of foreign investment and many changes in political institutions occurred during this period. The negative and positive trade-offs of foreign investment and government regulation became more clearly defined and politically charged during this era. The importance of foreign investment, institutional development, and economic growth has increased as globalization has advanced during the four decades since the 1970s.

Politics and Negotiations: The Effects of Political Institutions on Investment Arrangements Political institutions can serve as corrective mechanisms to the conflict of interest of foreign investors and host governments. Institutions impose structure and provide systems of incentives and constraints, all of which affect the capacity of governments to attract and utilize foreign investment effectively for development. Most improvements in the institutional capacity of domestic host governments also increase the profitability of foreign corporations. Government institutions tend to implement policies that benefit foreign firms by increasing incentives, expanding liberalization, and reducing transaction costs for multinational corporations. Over 90 percent of the regulatory changes made by host governments in the 1990s were favorable to foreign investors.12 In exchange, foreign investment can have a positive effect on domestic growth if the government has the capacity to negotiate arrangements that bring in capital, technology, employment, and greater integration into global trade. The capacity to gain benefits from foreign investment depends largely on four indicative institutional arrangements: regime type, government effectiveness, political stability, and the prevalence of corruption. Regime Type The effect of regime type, democratic or authoritarian, on government capacity to utilize foreign investment is paradoxical. Democratic accountability increases the need for governments to promote economic growth and distribute the benefits of hosting foreign investment. Centralized authoritarian control increases the capacity to implement policies that may be unpopular but may also expedite the process of economic growth.

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The presence of democratic versus nondemocratic government affects the use of foreign investment through mechanisms of accountability and legitimacy. Democratic institutions are designed to achieve an optimal balance of political and economic interests. Democratic accountability requires that the government extract benefits from foreign investment and allocate new resources to development programs in order to retain public political support for the regime and for hosting foreign investment. If optimality or equilibrium is not achieved, the public has the power to elect a government that will balance these interests. For example, instigating an economic recession that could have been avoided by more responsible economic policy, such as preventing the buildup of an insurmountable national debt, often decreases the legitimacy of the government. Responsive and legitimate governments constrained by competitive elections, are more likely to make responsible economic decisions.13 The failure to make such decisions will result in a decline of public support and a decrease in the mandate to govern. It is plausible that the opposite could be true. Authoritarian regimes may be more successful in managing foreign investment14 and promoting domestic economic growth. They have the power to implement difficult economic policy, such as shock therapy, in order to expedite economic transformation. Authoritarian regimes do not answer to public demands and special interest groups that may distort or delay the process of economic development. 15 The model of the Asian Tigers illustrates the economic success of command economies. As demonstrated in the Asian Financial Crisis, however, the rapid growth of the Asian Tigers was not sustainable in most cases. Regime type, the level of democracy as defined by the Polity Data, is tested as an institutional explanation of variation in the capacity to use foreign investment for domestic development. In the empirical analysis, regime type is statistically significant with a positive coefficient (refer to Table 2.1), which indicates that a democratic regime type has a positive effect on using foreign investment to increase domestic growth. This is attributable, in part, to democratic accountability and representation of a plurality of interests. However, regime type is a broad explanatory variable. It alone cannot fully specify the relationship between foreign investment and domestic development. Adam Przeworski and Fernando Limongi find no direct correlation between regime type and economic growth, although their classic study, “Political Regimes and Economic Growth,” identifies nuanced correlations at different levels of development.16 The more nuanced relationship requires specification and disaggregation of

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the contributing factors. As Joan Nelson explains, “The difference between democratic and authoritarian regimes may be less important than some more precisely specified institutional variables that cut across types of regimes.”17 To address this legitimate concern, it is important to incorporate more specific crosscutting variables such as government policy effectiveness, autonomy in decisionmaking, political stability, and corruption. Government Effectiveness Government effectiveness has a positive impact on the capacity of poor countries to use foreign investment for the promotion of domestic growth. Developing countries with more effective governing structures are able to negotiate more favorable arrangements with foreign investors than countries with diffuse and disorganized decisionmaking structures. Countries with high government effectiveness, measured as the capacity to formulate and implement policy, demonstrate a higher capacity to gain direct and indirect benefits from hosting foreign investment. This is primarily because the level of government capacity affects the level of vulnerability to external demands and interests. If a developing country has numerous agencies with jurisdiction over investment policy decisions but without cohesive development goals or implementation mechanisms, the system can be manipulated by external political actors. Diffuse or fragmented institutions make it difficult to initiate and implement investment policy. Fragmented institutions also make negotiations complicated and often prohibitive for host governments and foreign investors. Louis Encarnation and Dennis Wells explain that a diffuse approach is likely to be costly and suggest that countries seeking investment need to centralize their negotiation process and create a single decisionmaking structure.18 Coordinated and cooperative institutions should be able to formulate more beneficial policies as a result of their ability to form coherent development goals, centralize and consolidate their bargaining power, and provide fewer arenas for political manipulation or maneuvering by external interests. The statistical results reflect this dynamic: government effectiveness, as measured by policy implementation, has a statistically significant positive effect. This serves as additional evidence that deliberate, competent political institutions and government policies can increase the capacity to negotiate beneficial foreign investment arrangements. This makes foreign investment part of a successful domestic development strategy.

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Political Stability The effects of political stability are evident in two areas: the ability to attract foreign investment and the capacity to foster economic growth. Investors are risk averse. Macro political instability is a source of risk. Investors react to this risk, or instability, because the lack of consistency in the government’s capacity to rule the nation or to organize its society will create uncertainty in the market.19 Unstable political systems are not effective at designing and implementing consistent market and investment policy because they are in a state of flux. For this reason, it is doubtful that unstable systems can provide economic or political policies that contribute to economic growth. Political instability simultaneously discourages foreign investment and jeopardizes the feasibility of sustainable economic growth. A political environment in which uncertainty is minimized will foster economic activity and attract private investment.20 Political stability has a coefficient of 6.48, significant at the .05 level, which indicates that a one-unit change in the level of political stability predicts a multiple-unit change in gross domestic product (GDP) growth. A stable political system decreases risk, increases predictability, and provides consistent policy and practice regarding the domestic economy, foreign investment, and GDP growth. Corruption Corruption is insidious in the process of development. It distorts the relationship between foreign investment and domestic development by misdirecting resources. High levels of domestic corruption in government and business can also deter foreign investors because corruption increases political and economic risks. Corruption affects the negotiations with foreign investors, the transfer of benefits, and the “loss” or theft of resources. This has a negative effect on the correlation between foreign investment and development by “diverting” resources that the government might otherwise allocate for development spending on infrastructure, health, sanitation, education, standard of living, services, or other public goods. The level of corruption is accurately operationalized as lack of accountability and transparency in negotiations, decisions, arrangements, and practices. Corruption is a primary source of distortion in the relationship between political institutions and economic decisions and their combined effects on the benefits generated from foreign investment.

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The Effects of the Economic Environment on Investment Arrangements: A Political Economy Explanation The economic strategies that governments use for development will establish a structure of incentives and constraints for foreign investors. Governments must decide where their economies will fall on the spectrum from laissez-faire economics to command economies. This decision determines the level of government intervention in the economy. Specific political economy decisions can have a facilitative or prohibitive effect on utilizing foreign investment to promote development. The primary indicators of political economy that explain the relationship between foreign investment and development are: liberalness of the economy, level of economic development, size of the market, taxation policy, autonomy from external economic influence and external debt, and the value added of specific economic sectors, including the manufacturing, agricultural, service, and extractive sectors. The theory of economic determinism suggests that economic variables such as market access, debt, and taxation are the dominant sources of leverage in negotiating foreign investment arrangements. This presents an alternative explanation to the importance of political institutions. For example, conventional wisdom accepts that taxation deters foreign investors. It makes sense, intuitively: high taxes decrease the benefits (profits) of foreign investors. However, the failure to collect taxes also decreases the government’s capacity to finance domestic development. Even more compelling, several countries, including Chile, do not give any tax breaks to foreign investors; yet Chile has attracted more foreign investment recently than any other country in Latin America except Brazil. Cases such as Chile show up as outliers in the statistical analysis and thus are examined in-depth in the case study analysis. The statistical analysis does demonstrate that economic indicators alone cannot explain the variation in the capacity of governments to generate domestic growth from foreign investment. Alternative explanations are incorporated into the discussions of the political economy variables. Government Intervention in the Economy The liberalness of the economy affects the level of free trade, access to international markets, and the incentives and constraints for foreign investors and host governments. Laissez-faire economic theory posits that the greater the liberty of the economy, the greater the efficiency, productivity, and profitability of economic transactions. The freedom to

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buy, sell, trade, pursue employment, engage in international transactions, and form capitalist markets is crucial for economic growth and development.21 Neoclassical economic strategy is a reiteration of laissez-faire theory in the context of the global economy. It advocates free expansion of international economic transactions in order to maximize sources of growth. Neoclassical strategies also limit government intervention to minimize market distortion. If the economy is allowed to expand unrestricted or undistorted by government intervention, then expansion of the economy will result in expansion of the resources available to reinvest in domestic development. This proposition poses a challenge to pure institutional explanations that argue that government intervention, in the form of institutional constraints and incentives, counteracts the failure of the market to provide resources for development. Accordingly, liberalness of the economy is added to the analysis and tested for its explanatory value. The statistical results demonstrate that liberal economic management of the economy—coined by the World Bank as “good economic governance”—has a significant, positive effect on domestic growth. In the least-developed countries, good economic governance or economic management is as basic as maintaining a functional market system, with respect to fiscal and monetary policy, banking, financing, production, and consumption. It does not necessarily indicate a centrally planned system of supply and demand, although it does indicate that some aspects of production, consumption, and allocation are determined by political directive rather than private enterprise. “Government management” is distinct from “government intervention.” The level of government intervention in the economy is the most likely source of a development conundrum. A highly liberal market economy is able to attract foreign investors, thus bringing more funds into the developing country, but it is not able to compensate for market failures in the process of domestic development. Economist John Maynard Keynes recommends that the imposition of government controls and compensation for market failures be allowed, even in a liberal market economy.22 As Richard Fagen and others explain, “Hardly anyone argues anymore that the free play of market forces will bring in its wake movement toward the eradication of poverty, more equitable life chances, and other valued goals of development.”23 Government intervention is required to monitor economic exchange, enforce contracts, and coordinate economic activity to promote the process of domestic development. An increase in the liberalness of the economy will increase the overall level of foreign investment. In contrast, the lack of

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government intervention in the economy will produce suboptimal resources for domestic development. This is the dominant political economy conundrum for development. Institutional corrections for market failures can be used to make this paradox less problematic. A second, more intuitive political economy variable is international economic freedom—the absence of domestic political barriers to international trade. International economic freedom has a strong effect with a coefficient of 6.83, significant at the .01 level. This indicates that an increase in international economic freedom, such as free trade, correlates with an increase in GDP growth. The absence of political restrictions on international trade also has a strong effect on the initial attraction of foreign investment, as noted in the previous discussion of foreign investment, thus emphasizing the wide impact of the freedom to trade internationally. In comparison, domestic economic freedom has a large but not statistically significant effect, which indicates that government can impose restrictions or requirements on production and consumption without affecting the relationship between foreign investment and growth. Level of Economic Development The level of economic development affects the degree of acceptance of foreign investment as a development strategy. The least-developed countries, with the lowest GDP per capita, have the most urgent need to alleviate poverty, as well as the fewest domestic resources to devote to this cause. Thus, they are more amenable to hosting foreign investment. The level of development correlates with information access, economic stability, economic diversity, and technical capacity. Low levels of these assets can increase developing nations’ tolerance for the negative externalities from hosting multinational corporations.24 Concessions will be made to foreign investors based on the need of developing countries to compensate for their low level of development. Investors find this to be a favorable environment. It increases the concessions the host country is willing to make, the degree of leverage foreign investors can assert in political and economic decisions, and the overall level of profitability. In contrast, the level of development can also have an adverse effect on the decision to invest. The least-developed countries have the smallest consumer markets, lowest purchasing power, inadequate infrastructure, unskilled labor, and insufficient feeder industries to support the successful operation of foreign direct investment. It is plausible that low

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levels of development may encourage domestic acceptance of foreign investment while simultaneously discouraging foreign companies from investing. Government Revenue: Taxation The political economy of taxation presents a paradox. Taxation may discourage foreign investment if the level of taxation is too high or the policy of taxation is discretionary based on corrupt cronyism or patronclient arrangements. However, a lack of taxation of foreign enterprises will decrease domestic government revenue and thus decrease the amount of government development spending. The paradox poses a trade-off between maximizing indirect benefits (such as technology transfer) while minimizing direct benefits (government revenue), or maximizing direct benefits and thus increasing domestic development spending at the cost of decreasing the overall amount of foreign investment and indirect benefits. Taxation decreases the bottom line for foreign investors, and thus may discourage initial investments. However, taxation generates direct revenue for the governments of the developing countries. It creates revenue by taxing a part of the profits of foreign investments, expanding the tax base to include income from new jobs, and increasing the efficiency of government extraction. In addition, increasing the tax base and improving the government’s capacity to collect taxes may also increase the public demands on how the government spends the tax revenues. In this way, taxation can be used as an indicator of the capacity a country has to achieve its development policy goals. Marina Arbetman and Jacek Kugler refer to this capacity as Relative Political Extraction, a variable that measures a government’s ability to gather the revenues required to implement a desired policy.25 For developing countries the ability to generate revenue is highly contingent on the ability to attract and maintain foreign investment. Most developing countries attract foreign investment by offering cheap labor and generous tax abatements, such as minimal taxation of profits, capital, sales, resource use, and waste disposal. The domestic host governments generate revenue by taxing the newly employed laborers’ income. However, taxation of low wages is not lucrative in comparison to taxation of large corporate profits. In addition, the profits made by foreign investors are primarily repatriated, with only a small percentage being reinvested in host country capital assets. Consequently, domestic governments are generating little direct revenue

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from serving as hosts to foreign investment. The direct benefits of raising government revenue and increasing development spending are often forfeited in order to increase the overall level of foreign investment and gain indirect benefits therefrom. Most scholars warn against taxing foreign profits. By taxing foreign firms, developing countries become less competitive in attracting foreign investment. In contrast, other scholars argue that taxation is less important than political and economic variables. The decision to invest is influenced more by the degree of access to markets, access to resources, and freedom from government intervention, rather than the amount of subsidies and tax breaks poor countries are able to offer foreign investors. Many analysts also include debt with this list. Foreign investors are less influenced by government tax holidays and subsidies than they are by debt, which is often considered a high risk factor. For investment speculators, debt can predict future political economic trends. Investors ask will a government raise new taxes to pay for higher spending, or will it seek to borrow money? If the answer is “tax,” one should expect the markets to be relatively unconcerned—even if some of those revenues are raised by capital taxation. But if the answer is “borrow,” the markets know that the government will have an incentive to inflate in the future to try to reduce the real cost of their debt.26

Taxation may not be as prohibitive to foreign investment as previously thought. Empirical evidence shows a steady and strong rise in capital taxation from the 1970s through the 1990s, which is “a long way from predictions of a free fall in capital taxation resulting from the exit threats of multinational firms and financial speculators.”27 To contribute to this debate, taxation policy is tested to determine if it has an effect on the relationship between foreign investment and development, and if the relationship is paradoxical. The results show that the level of taxation has a statistically significant positive effect on the relationship between foreign investment and domestic economic growth. This correlation occurs, ostensibly, because taxation becomes government revenue that can be invested in programs to promote economic growth. However, taxation has a strong negative impact on the initial attraction of foreign investment (review Table 2.1). The economic trade-off is evident. The decision, however, is a political decision: decrease taxation to attract an overall increase in foreign investment, but benefit less from that investment; or increase taxation, attract less overall foreign investment, but benefit more from that investment.

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Institutional Autonomy: Level of Independence from Exogenous Economic Interests The level of dependence on external resources, such as external loans and foreign grants, affects domestic political and economic decisions. As articulated by dependency theorist Jeffrey Leonard, foreign investors command a powerful political lever by means of which they may seek to influence governmental decisions.28 A high level of dependence on foreign resources decreases the relative autonomy of domestic institutions, thus shifting the locus of power to the foreign investors. This creates a favorable environment for increasing foreign investment, but it decreases the power of domestic governments to extract benefits from foreign investment. However, endogenous development spending cannot be substantially increased without exogenous economic resources, thus the foreign interests often become institutionalized in the decisionmaking process of developing countries. Economic growth is designed to first benefit the interests of foreign investors. The investments made by [foreign investors] in underdeveloped countries are often seen as inhibiting economic growth, since they are more than offset by excessive rates of capital repatriation to the industrial core . . . These patterns undermine the autonomy of the periphery. Multinationals become major, if not dominant, forces in economic policy making, a position they maintain by means of an implicit threat of withdrawal from, and consequent loss of capital by, the host country.29

The level of institutional autonomy from foreign economic leverage and political influence is a causal variable in the capacity of governments to utilize foreign investment for domestic development. Although autonomy is difficult to quantify, autonomy from foreign economic power can be reasonably measured as the sum of external debts and foreign grants. A high level of dependence on external debt and foreign grants, as is the case in most of the developing world, decreases the level of autonomy poor countries have to determine their own arrangements with foreign investors, particularly foreign investors from the financier and creditor countries. Economic Sectors Distinct economic sectors vary in their ability to attract and generate benefits from foreign investment. Sectors vary in technology, risk factors, global integration, and flexibility or adaptation to international

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market forces and domestic politics. The industrial manufacturing sector attracts the highest overall level of foreign investment worldwide and continues to increase over time. Foreign investment in the agricultural sector is increasing as agribusiness, or corporate-scale agricultural production, increases. Despite its wide pervasiveness in the developing world, the agricultural sector often demonstrates the lowest level of direct benefits in comparison to the manufacturing, extractive, and service sectors. The service sector is growing at an unprecedented rate but the growth is tightly concentrated in a very few countries. Foreign direct investors in the service sector and portfolio investment brokers of service stocks invest almost exclusively in the BRIC countries (Brazil, Russia, India, and China). Foreign investors in the extractive sector, or extractive industries, operate differently than investors in all other sectors. Investments in the extraction of oil, gold, diamonds, water, and other valuable natural resources will be made at the location where the resource is located regardless of almost any political or economic indicators. For example, investors will invest in oil whether the oil is located in a developing country that is experiencing civil war, human rights abuses, economic collapse, or political turmoil, or operates with extremely corrupt practices. The interests of governments and investors also vary across economic sectors. As Leonard explains, there has been “an increased presence of manufacturing and service corporations. Politically, this trend is likely to be extremely important. The interests of manufacturing companies are considerably different from those of the oil and mining companies.”30 In addition to the difference in interests, there is variation in the profitability of distinct sectors. The manufacturing sector has become the keystone of industrialization in most developing countries, as well as the most lucrative. However, there are differences between manufacturing pharmaceuticals, microchips, and automobiles versus plastic toys. For this reason, the manufacturing sector will be specified as advanced or basic. Both segments of the manufacturing sector will be tested separately. The second-largest increase in investment has occurred in the service sector. The increase of investment in the service sector is attributed to government privatization of transportation, public utilities, and professional services. Foreign ownership of these services may affect the goals of development and how the benefits are distributed. Foreign investment in the manufacturing, extractive, agriculture, and service sectors are tested here for their explanatory value in the success of for-

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eign investment as a development strategy. The development or improvement of specific economic sectors, measured as value added, does provide an attractive incentive for foreign investment and does increase government revenue. For example, the existence of valuable minerals or sources of fuel leads to an increase in the potential profitability of the extractive sector, which provides an incentive to invest (review Table 2.1). The value added of specific economic sectors is a statistically significant determinant of government revenue from foreign investment. Most developing countries demonstrate the existence of the four main economic sectors: manufacturing, extraction, agriculture, and service. Variation among the sectors is found in the value added by year. The manufacturing, extractive, and service sectors are statistically significant at the .05 level. This demonstrates that an increase in the value added of one of these sectors increases the amount of government revenue. The agricultural sector does not prove to be statistically significant, which suggests that an increase in foreign investment in the agricultural sector does not have a strong affect on the level of domestic economic growth.

The Interaction Effects The results of the empirical analysis provide evidence that the interactive effects are statistically significant and increase the explanatory value of the model. The interaction of foreign investment with democratic institutions and government effectiveness has a strong positive effect on the capacity of poor countries to promote domestic economic growth. The Cross-Sectional Time Series regression results summarized in Table 2.1 illustrate the effects of political institutional design and the level of foreign investment on the level of GDP growth per capita. The results indicate that several of the variables increase in statistical significance with the addition of interaction effects to the empirical model. First, the results suggest that regime type, government effectiveness, political stability, economic freedom, taxation, and the level of foreign investment are statistically significant. Without the inclusion of interaction effects, the coefficients and statistical significance are not evident or not as strong for the independent effects of foreign investment inflows and stocks. With the inclusion of interaction effects, foreign investment inflows and stocks have higher coefficients and are statistically significant in explaining changes in GDP. The significance of for-

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Table 2.1

The Interaction Effects of Political Institutions, Political Economy, Foreign Investment, and Economic Growth Coefficients

Regressor Regime Type: Democracy Government Effectiveness Political Stability Corruption External Debt Domestic Economic Freedom International Economic Freedom Taxation of Foreign Investment Level of Development, GDPpc FDI Net Inflows FDI Stock Portfolio Investment Interaction: Democracy x Investment Interaction: Effectiveness x Investment Economic Sector: Manufacturing Extraction Agriculture Service Control: Population Constant Adjusted R-square Number of Cases

Institutions & IPE on Foreign Investment

Institutions & IPE on GrowGDP

Interaction Effects on GrowGDP

5.43* 1.01* 2.10* 1.71* –.026** 2.20* 2.45** –3.17** .025*

6.10* 4.21** 6.48* 2.44* –.010 8.72 6.83** 2.51*

9.40** 2.82** 11.15** 3.98* –.001 13.80** 1.23** 2.20*

.002* .001 .001 .004* 1.24* .013* .004* 8.408** 267.5*

.001* 2.16* .048 .007* .376 160*

1.20** .090* .031* 2.61* 2.32** .001* 3.81* .005 .001* –.166 284*

.598 865

.441 901

.647 901

* Indicates statistically significant at the .05 level, two-tailed test. ** Indicates statistically significant at the .01 level, two-tailed test.

eign investment is substantively important in this model because the results suggest that the overall level of foreign investment is a significant factor in domestic growth if the empirical model includes the interaction effects, which constitutes the properly specified model. However, the inclusion of the interaction effects demonstrates that the level of foreign investment becomes more significant when accompanied by democratic and government effectiveness. With the interaction effects, foreign investment is more highly correlated with domestic economic growth. Second, the regression results suggest that the addition of interac-

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tion effects increases the explanatory value of the model from an Adjusted R-square of .441 to a more compelling Adjusted R-square of .647. This basically means that adding the interaction effects provides the model with evidence to explain 20 percent more of the actual relationship than the model without the interaction effects. Accordingly, excluding the interaction effects of democratic and government effectiveness is a theoretical mistake and an empirical misspecification of the model. This strongly supports the central argument that domestic growth from foreign investment is contingent on democratic development and institutional capacity. The regression results also support the hypothesis that democracy has a direct positive effect on the ability of governments to translate foreign investment into domestic growth, with a comparatively high coefficient of 9.40. The independent effect of democracy is stronger in the equation that includes the interaction effects. This effect is statistically significant at the .05 level in the noninteraction effects model and is significant at the .01 level in the interaction effects model. This indicates that the empirical model is more accurately specified with the inclusion of the interaction effects variables. In addition to the independent effects of democracy, the interaction effects of democracy with foreign investment have a coefficient of 2.61, statistically significant at the .05 level. The interaction effects model demonstrates the significance of the interaction of foreign investment with democratic institutions in order to facilitate domestic growth. A similar result is found regarding government effectiveness: the interaction effects of the variables are as important as the independent effects. The analysis supports the hypothesis that government effectiveness has a direct positive effect on domestic growth with a coefficient of 2.82 statistically significant at the .01 level. The variable for good governance is also tested for an interaction effect based on the theoretical proposition that political institutions and foreign investment interact to affect the domestic economy. The empirical analysis shows a strong positive interaction effect with a coefficient of 2.32 and significance at the .01 level. As with the analysis of regime type, the inclusion of the interaction effects of government effectiveness in the empirical analysis is required for a properly specified model and a compelling explanatory value. One of the most informative results is that the interaction effects of foreign investment with democratic and effective institutions are as important as the independent effects of the level of foreign investment.

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The overall level of foreign investment is negligible in the regression equation that excludes the interaction effects. However, the regression equation that does include the interaction effects, demonstrates the statistical significance of both the level of foreign investment and the interaction of foreign investment on generating economic growth. This indicates that the quality of the investment environment is more important than the quantity of foreign investment. The quality of the investment environment is determined, in large part, by the institutions designed to effectively negotiate and manage the operations and domestic impacts of foreign investment. The interaction coefficients for democratic and effective institutions are, respectively, coefficient 2.61 and 2.32, statistically significant at the .05 and .01 levels. This demonstrates that the interaction effects of democratic and effective institutions with foreign investment have a significant impact on the capacity to generate growth. In other words, the interaction of foreign investment with domestic governing institutions affects the correlation between foreign investment and domestic economic growth. The final variable, political stability, increases substantially in its coefficient and significance with the addition of the interaction effects. With the interaction effects, political stability has a coefficient of 11.15 and is significant at the .01 level. Without the interaction effects, political stability is not as significant in the relationship between foreign investment and domestic growth. However, the clear importance of political stability is witnessed in its effect on the ability to attract foreign investment. In previous research with this database, political stability has been shown to have a statistically significant effect on the overall level of foreign investment, which indirectly affects this model. Returning to the central research focus on the relationships among foreign investment, government capacity, and domestic growth, the interaction effects of foreign investment with political institutions and economic variables are dynamic over time. The CSTS analyses address specific aspects of the temporal variation; however, the analyses do not represent lagged effects, which must be tested separately. The theoretical framework used for this research suggests that the relationships among foreign investment, political institutions, and economic factors are most significant during the initial negotiation of the investment. The capacity for negotiation and the leverage asserted by foreign investors and host-country decisionmakers affect the initial terms of the investment, which in turn affect the long-term balance of benefits from foreign investment.

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Conclusion The use of foreign investment to promote domestic development is contingent on the interaction effects of foreign investment with democratic and effective institutions. Foreign investment is premature in countries with weak political institutions and perverse economic policies. In contrast to this negative prognosis, one of the positive conclusions of this analysis is that developing countries are not doomed to economic determinism. The relationship between foreign investment and domestic development cannot be explained by economic variables alone. The role of political institutions is statistically significant and theoretically substantive. Improving the quality of political institutions can increase the capacity of governments to maximize domestic benefits and minimize negative externalities from hosting foreign investment. Thus, underdeveloped countries must focus on strengthening democratic accountability and institutional capacity in order to establish mutually beneficial investment patterns. The results of the statistical analysis contribute to the larger debate regarding foreign investment and domestic development by adding the following conclusions: • Achieving economic growth from foreign investment is not solely a function of the total amount of foreign investment. The variation in economic growth is wider than, and disproportionate to, the amount of foreign investment. • The interaction effects of democratic and effective institutions with foreign investment are statistically significant. The amount of economic growth generated by foreign investment is contingent on the interaction of foreign investment with institutions that improve the investment environment and manage the balance of the benefits. • Inclusion of the interaction effects increases the explanatory value of the empirical model. The relationship between foreign direct investment and domestic development cannot be explained by economic variables alone. The explanatory value of the model is higher with the interaction effects of institutional variables. Previous work has focused too heavily on how to attract foreign investment and not on how to utilize it. The fallacy is that an increase in foreign investment translates directly into an increase in growth and funds for development. The results provide evidence that the benefits of

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foreign investment are contingent upon specific institutional arrangements. It is important for developing countries to recognize the significance of deliberate institutional designs, such as democratic development and institutional coherence, to manage the costs and benefits of hosting investment. Deliberate institutional design can serve as a corrective mechanism to market failures that distort the benefits of foreign investment. The divergent interests of foreign investment and domestic development have created a disequilibrium of benefits. The benefits can be brought closer to an equilibrium through institutional mechanisms such as incentives and constraints, accountability, transparency, efficiency, and efficacy. The results of the analysis demonstrate that in order to use foreign investment effectively, developing countries must focus on political institutional development to increase their capacity to negotiate and manage foreign investment to promote domestic development. The limitation of the cross-national analysis is that it cannot generate conclusions about the intricacies, complexities, and causal mechanisms driving this relationship. The in-depth analysis of foreign investment in Kenya, Nigeria, India, Malaysia, Chile, and Mexico exposes the causal mechanisms and identifies specific strategies that developing countries can use to maximize the benefits and minimize the externalities from hosting FDI. The case studies examine the wide variations in the investment environments, negotiation strategies, market access, incentives, constraints, and the effects of change over time on the relationship between foreign investment and domestic development.

Structural Change and the Investment Environment After the initial negotiation and investment, the relationship between foreign investors and domestic governments may change. Structural changes in political security and economic stability may trigger changes in the investment environment. In developing countries the fundamental changes are democratic transitions and market reforms. These structural transitions, as Arbetman and Kugler suggest, “directly and significantly shape patterns of development.”31 Investment arrangements and development strategies are not static. Even if the initial investments are intended to be static, such as 100-year contracts, the investment environments of developing countries are dynamic. A major transition in political leadership or economic policy may expose corruption, inefficiency, inequity, and negative externalities from foreign investment.

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These problems challenge the legitimacy of the initial investment. They may prompt host governments or foreign investors to renegotiate the arrangement. It is theoretically plausible that the importance of the investor-host relationship decreases over time. The terms of the investment are established at the outset. However, in-depth analyses of long-term foreign investments in India, Mexico, Kenya, Malaysia, Chile, and Nigeria demonstrate that investments are renegotiated regularly. The country case studies expose ongoing negotiations between foreign investors and host governments. They illustrate the contextual factors and causal mechanisms that are not captured in the cross-sectional statistical correlations. The cases clarify the specific institutional arrangements, policy decisions, parliamentary legislation, and executive decrees that maximize the domestic benefits of hosting foreign investment. The comparative analysis can also highlight the learning process across states. It can identify the diffusion of information about strategies for negotiating and managing foreign investment.

The Effects of Globalization on Structural Change and the Investment Environment The effects of globalization should not be exaggerated. But neither should they be ignored. The process of globalization has four elements that directly affect the role of foreign investment in domestic development. First, the diffusion of ideas and information across borders offers developing countries new strategies for negotiating with foreign investors and managing multinational corporations. This learning process, or diffusion, is particularly important in order for underdeveloped countries to regain control over policies that have been commandeered by international, individual foreign investors. Second, globalization has fostered structural change by legitimizing democracy as the dominant form of governance, and establishing capitalism as the common denominator for international economic activity. Third, foreign investors are viewed as international actors with the power to influence the governments and economic policies of the countries in which they invest. Fourth, in contrast to the empowerment provided by access to ideas and information, globalization reduces state autonomy in the process of establishing and enforcing rules, regulations, incentives and constraints, and competition. The idea that there could be a “balance,” or equilibrium, of the effects of globalization remains highly contentious.

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The main effects of globalization are discussed in more depth through the following section in order to illustrate the current state of the debate. Foreign investors function as international political actors. They command powerful political levers through which they influence government decisions. Globalization has extended the reach of these investors in all parts of the world, particularly in underdeveloped countries. It has also expedited the diffusion of information and thus facilitates learning across national borders. Knowledge of the diverse strategies used in other countries increases the options available for promoting development. Additionally, it provides information about specific strategies that are successful under different conditions. The process of learning through global diffusion accounts, in part, for changes countries make in their strategies for generating benefits from foreign investment. Over time, developing countries become more informed and their governments become more capable of responding to international challenges. Globalization of the economy also affects national sovereignty. The autonomy of domestic governments to make decisions regarding development is altered by the presence of international actors. Foreign investment advisers and multinational corporation executives have immense economic and political power. For example, tax incentives and government subsidies may be predetermined by the demands of foreign investors rather than the preferred policies of the domestic governments. This increases the influence of the foreign corporations and investors, and decreases the autonomy of governments to determine their development strategies. It also allows for “blatant political manipulations [to be] undertaken by some companies in developing countries.” 32 Foreign investment has the leverage to affect the political decisionmaking process, type of taxation, level of government revenue, and pattern of development. To examine these dynamics more closely, the investment arrangements of General Motors Corporation are disaggregated and analyzed in the six country case studies, which expose wide variation in global investments.

The Global Operations of General Motors General Motors (GM) is one of largest multinational corporations in terms of revenues and foreign assets, including capital investment, financial resources, production, sales revenue, and number of world-

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wide locations. The largest American corporations by revenue are Exxon, General Motors, General Electric, and Ford; and the largest American corporations by foreign assets are Ford, General Electric, Exxon, and General Motors. 33 It is reported that in one of General Motors’ strongest years, sales revenues ($133 billion per annum) were equal to the combined gross national product (GNP) of Tanzania, Bangladesh, Zaire, Uganda, Niger, Ethiopia, Nepal, Kenya, and Pakistan. In 2007, GM had manufacturing operations in 32 countries, sold vehicles in 200 countries, and maintained approximately 324,000 employees worldwide. In the past decade, General Motors has purchased over $105 billion worth of goods and services from more than 25,000 global suppliers.34 The company, however, suffered substantial setbacks in the early 2000s, with a $10 billion loss in 2005–2006, and an unprecedented $38.7 billion loss and 35,000 job loss in 2007, which is part of a jobrestructuring program to buy cheaper international labor. Yet GM remains positioned in the global market to make a strong recovery, albeit through mergers and bailouts. In addition to paying for the jobrestructuring program, GM’s 2007 “losses” are attributable to expensive buyouts and acquisitions. General Motors has also become the top-selling auto company in China, which is one of the fastest-growing consumer markets in the world and puts 2000 new cars on the road every day. Most important, even in the midst of the loss of 2005–2006, GM was working to reverse its fortune through negotiations with international suppliers, such as the previously GM-held Delphi parts manufacturer in Mexico, and with US government agencies, such as the Securities and Exchange Commission (SEC). For example, in 2006 the SEC approved accounting changes that turned GM’s $323 million first-quarter loss into a $445 million profit.35 This deliberate reversal of fortune demonstrates that General Motors is committed to being a highly effective multinational operation, and is capable of renegotiating accounting arrangements to increase profitability. The corporation engages in a constant process of reevaluating and restructuring its international investments, and it makes a coordinated effort to increase the production and consumption of GM products in the global market. With a long history of foreign investment in a wide range of developing countries, General Motors has demonstrated that it is not an “absentee landlord” to its international investments. General Motors, as with all foreign enterprise, invests overseas to minimize costs, maximize profits, and maximize access to international markets. In order to

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do so, it maintains a tightly organized and highly centralized executive group to manage its overseas investments. In March 1978, General Motors initiated a major reorganization of its overseas operations in order to provide closer management and better coordination with the North American operations. The position of group executive in charge of overseas operations was created, with five vice presidents reporting to that position, each with responsibility for a geographic region.36 This reorganization has allowed GM, over the decades, to effectively control its international production and consumption through a centralized group of executives. General Motors has also continued to modernize its foreign factories and assembly lines by increasing the quantity and quality of technology transferred overseas. The greatest addition to foreign capital was in 1980, when GM announced that it would spend $40 billion from 1980 through 1984 in a worldwide program to redesign its vehicles and modernize its assembly plants.37 This financial investment increased the capital investment and technology transfer from GM to the foreign countries in which it had manufacturing and assembly plants, including all four cases in this study. As criticisms of foreign investment became more prevalent in the mass media during the late 1980s, when many of the exploits of foreign investors such as unsafe working conditions and sweat shops were exposed, international and domestic pressure increased regarding GM’s role in the international labor market. For example, two of the cases in this study, Chile and Malaysia, successfully legislated new domestic labor requirements for foreign investors during this time and managed to get GM to comply with the new standards, which are discussed in more detail in the following analysis. In 1982, General Motors International Operations (GMIO), the United Auto Workers (UAW), and General Motors America (GMA) signed a new labor agreement that emphasized joint training, profit-sharing, and improvements in competitiveness, quality of work life, and job security provisions, including the Guaranteed Income Stream. Although most of the benefits of this new labor agreement were distributed to workers in the United States and northern Mexico, countries in this study such as Chile and Malaysia, with governments that were attentive to these changes, were able to acquire some of the benefits for their domestic labor. Kenya also made an effort to enforce its legislation regarding domestic labor and joint ventures during this time, although with less success. This distinction is important because although GM has agreements (or policies) and a centralized executive, the agreements are not consistently applied in all of the countries in which GM invests. The purpose of the executive deci-

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sionmakers is not to coordinate the policies or to make agreements consistent across countries but, rather, to coordinate production and consumption in the interest of minimizing costs and maximizing profits. In the early 2000s, General Motors further centralized the executive powers that make decisions regarding foreign investment. In 1998, GM eliminated the business sector and the five GMIO vice presidents and consolidated all worldwide automotive operations into a single organization, GM Automotive Operations, in an effort to increase the profitability and international competitiveness of GM’s foreign operations. General Motors continues to be actively engaged in increasing the profitability of its international investments, and demonstrates a high corporate capacity to reorganize, reform, and improve its overseas operations. The following chapters explore the interaction of General Motors with the governments of the countries in which it invests.

The Elements of Comparison To capture the dynamism of investment and development, the comparative case studies examine foreign investment arrangements in six developing countries with distinct development patterns: Kenya, Nigeria, India, Malaysia, Chile, and Mexico. The cases of Chile and Mexico, for example, have outperformed most of Latin America in attracting foreign investment and utilizing it for domestic development. Mexico has made a transition from being one of the world’s most protectionist economies to becoming one of the most neoliberal. It has transitioned out of import substitution industrialization (ISI), and has established an export-oriented industrialization (EOI) development strategy. Mexico has also been improving its political and democratic accountability through competitive elections, after seventy years as a single-party state, and the government is working to reduce crime and corruption, which deter investors. The domestic political and economic liberalization are occurring under the auspice of the North American Free Trade Agreement (NAFTA), which influences the incentives and constraints imposed by the Mexican government on foreign investment. Chile’s democratic transition increased the transparency of the investment process, decreased corruption and discretionary decisionmaking, and maximized the freedom of production and consumption. Investors have recognized Chile as a predictable and profitable investment environment. In exchange for Chile’s capacity to lower risk by increasing transparency and predictability, multinational corporations

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have been willing to pay a nondiscretionary tax rate to the government in order to operate in Chile. The government has been able to collect taxes, without offering tax breaks or large subsidies to foreign investors, and has used this revenue to reinvest in infrastructure, education, public goods, and services relatively congruent with the democratic-socialist underpinnings of its constituency. Institutional development has also improved the relationship between foreign investment and domestic development in Kenya, although to a different degree than in Chile and Mexico. Kenya is in the process of democratization and market reforms but has suffered substantial setbacks. It is still vulnerable to corruption, discriminatory application of investment policies, and a volatile political environment. Despite these obstacles, the government has been able to negotiate a few benefits from hosting foreign investment. Foreign investors absorb part of the cost of infrastructure development. For example, the government negotiated for General Motors to pave roads that the public needs for transportation to work, for daily business, and to reduce the costs of maintenance on their vehicles. This was possible despite Daniel arap Moi’s fledgling political regime, because General Motors also needed to have these roads paved in order to maintain its operations and sales. The arrangement was more attributable to serendipity, or common interests, than coherent negotiation strategies. This success is one of a small few in Kenya’s negotiations with foreign investors. Kenya has experienced widespread divestment as a result of its political instability and economic uncertainty. India has made remarkable progress in political and economic development by being able to attract large, lucrative, and competitive foreign investments. India has transitioned to an EOI strategy, with a specialization in telecommunications and the service sector. It is also the world’s largest democracy and the second-largest consumer population. India has managed to attract foreign investment inflows by improving the investment environment. The government helps develop, construct, and finance infrastructure projects that appeal to foreign investors. These projects include state-of-the-art High Tech City buildings, backup electrical sources, high-end condominium towers for foreign executives, and automatic approval of almost 95 percent of all proposed investment arrangements. There are concerns, however, that deter foreign investors away from India, such as inadequate infrastructure, domestic political instability, clashes with US foreign policy, and other political and economic risk factors. Several Western business buildings and foreign firms have been

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attacked; and hundreds of business commuters were killed in train bombings in Mumbai in the summer of 2006. The United States has also threatened to impose sanctions on India for its nuclear weapons and long-range ballistic missile testing, as well as its failure to contain violence near the border with Pakistan. Improvements have been made in order to attract foreign investors, but India is still plagued with an erratic energy supply, extensive pollution, urban health and sanitation problems, and an inconsistent and clogged transportation infrastructure. The Malaysian government has retained more control over its economy than India, including the discretionary management of foreign investment. The government regulates production and consumption, in large part to protect domestic industries, but attracts foreign investors with substantial financial incentives such as ten-year tax holidays. It has not attempted to maximize government revenue from the investments, in contrast to the goals of Chile and Kenya. The government has focused on gaining indirect benefits from foreign investment such as technology transfer. Malaysia has been highly successful in these areas. It has been able to support an export-oriented economy primarily in the technology sector and increase the level of employment for the general population and ethnic Malay. Outside of the oil industry, Nigeria has not achieved a comparable level of success with foreign investment. The Nigerian government lacks the institutional organization, well-formulated policy, and enforcement capacity that allow Malaysia to benefit from foreign investment. It also lacks the institutional reforms, democratic development, and accountability that promote Chile’s use of foreign investment for domestic development. With the exception of multinational oil corporations, most investments in Nigeria are operating below capacity or are divesting. Nigeria poses several risks to foreign investors: corruption, discretionary decisionmaking, political and economic instability, and a poor level of infrastructure development. As a result, Nigeria has not been able to attract a substantial amount of foreign investment or extract sufficient benefits to advance domestic development. The theory guiding this research explains that differences in the ability to manage foreign investment in the cases of Chile, Mexico, Kenya, India, Malaysia, and Nigeria are a function of government capacity, democratic accountability, effective policy implementation, and the subsequent political and economic arrangements negotiated with foreign investors. The case studies expose the causal mechanisms operating behind the cross-national analysis. A comparative case study (CCS) is conducted to refine the empirical model and to make the causal mechanisms

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explicit. The theory behind using cases is best articulated in Arend Lijphart’s work Comparative Politics and the Comparative Method, which states that “case studies can make an important contribution to the establishment of general propositions and thus to theory-building in political science.”38 Ira Katznelson expands this argument by developing the idea of configuration models that include historical factors, structural factors, and micro foundations into the analysis of causal mechanisms.39 Based on Katznelson’s configuration model, the qualitative case studies will incorporate the same macrolevel institutional and economic variables as the quantitative analysis. However, the case studies will add contextual factors, structural change, and microlevel factors such as local variations in individual investments, which are beyond the scope of the quantitative analysis. The specific comparative cases for the qualitative analysis are as follows: Kenya. The attack on democratic institutions under Moi’s regime, the divestment of foreign firms, and the renewal of the democratic transition, 1990–2008 (emphasis on executive regimes: Moi to Kibaki). Nigeria. The progression of coups and military rule, the intermittent

attempts to establish democracy, the divestment of foreign firms, and the failure to diversify the market outside the oil industry, 1983–2008 (emphasis on executive regimes: Buhari to Yar’Adua). India. The consolidation of multiparty democracy and the transition to

an export-oriented development strategy, 1991–2008 (emphasis on executive regimes: Rao to Singh). Malaysia. The process of economic modernization and the development

of a highly structured bureaucracy, 1981–2008 (emphasis on executive regimes: Mahathir to Abdullah). Chile. The transition to democracy after Pinochet’s regime and the

adjustment to neoliberal economic reforms, 1990–2008 (emphasis on executive regimes: Pinochet to Bachelet). Mexico. The evolution from a single-party to a multiparty democracy,

the transition from import substitution to export-oriented industrialization, and the neoliberal adjustments to NAFTA, 1994–2008 (emphasis on executive regimes: Zedillo to Calderon).

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The cases are selected systematically according to specific criteria. The selection criteria focus on variation in the independent variables, statistical significance of the interaction effects, falsifiability of the central statistical findings, and the impact of direct investment, not portfolio investment. The first specific selection criterion is that the political institutions and economic factors must vary. To be accurate and informative, this CCS examines states that are democratic and nondemocratic, institutions that are coherent and incoherent, economies that are strong and weak, and governments that have high and low levels of intervention in the economy. The cases for this study are not selected on the dependent variable, which would ensure a specific outcome. The cases are selected to provide maximum variation of the independent variables. In addition to representing variation, it is equally important to have a constant. The constant helps define what is and what is not explained. This analysis examines how variation in political and economic factors affects the capacity of domestic governments to negotiate foreign investment arrangements. It does not analyze corporate size or structure. Thus, corporate capacity is held constant while government capacity is varied. This is accomplished by studying a single corporation, General Motors Corporation, in a number of different countries with distinct political and economic environments. The case selection criteria also meet the requirements of falsifiability and “most likely, least likely”40 case selection. Karl Popper asserts that an argument is ineffective and cannot be supported if there is not the possibility that it could be proven false.41 The only acceptable standard for verification of a theory is that it holds up against falsification. For this reason, cases are selected that could potentially falsify the theory. The least likely cases to support the arguments are Kenya and Malaysia. Numerous nondemocracies have been successful at utilizing foreign investment to promote domestic economic growth, particularly in East Asia. The most likely case to validate the results of the statistical analysis is the democracy with coherent institutions, such as Chile, which demonstrates the capacity to establish beneficial investment patterns. Deductive analysis will determine whether the cases support or falsify the theory presented in this research. The second criterion is that the case study evidence is relatively stable, not incidental. This requires that the investment cases consist of direct capital investment, not portfolio investment. The qualitative case analysis is designed to complement the quantitative data analysis. In order for the

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analyses to be compatible, the cases should include investments that have been active for approximately thirty years. Direct capital investment can be analyzed for change over time, which clarifies the causal mechanisms in the relationship between investment and development. The comparative analysis provides a substantive evaluation of foreign investment arrangements in four analytic categories: incentives and constraints; direct and indirect benefits; investment arrangements with General Motors; and structural change and catalysts for renegotiation. It focuses on the intricacies and complexities of negotiating and managing foreign investments. Thus, the broad analytical categories are disaggregated into specific indicators: (1) incentives and constraints—code of conduct, role of investment promotion agency, regulation of production and consumption, tax policy, labor pool, market access, corruption, discretionary application of policy, transparency of decisionmaking, performance requirements, infrastructure, raw materials, environmental externalities, and other sources of leverage in negotiations; (2) direct and indirect benefits—government revenue, multinational corporate profits, expansion of industrial sector, increase in value-added exports (manufactured goods), new employment, employee benefits (health insurance), skills training, technology transfer, infrastructure development, service provision, financial and humanitarian aid programs; (3) the specific investment arrangements with GM that are unique by country case; and (4) the structural change and catalysts for renegotiation that are unique by country case. Each of these specific indicators is compared across cases in order for the analysis to be consistent and systematic. The study examines the wide variation in the capacity to establish mutually beneficial arrangements with foreign investors, with an emphasis on General Motors, in Kenya, Nigeria, India, Malaysia, Chile, and Mexico. It exposes the negotiation strategies, incentives, constraints, and outcomes of specific investment arrangements between General Motors and host governments.

Notes 1. Samuel Huntington. 1987. “The Goals of Development.” In Understanding Political Development, edited by Myron Weiner and Samuel Huntington. Harper Collins 1987; Waveland Press 1994. 2. United Nations Conference on Trade and Development. 1999. World Investment Report. FDI and the Challenges of Development. New York: United Nations. 3. A formative discussion of advocates and opponents of using foreign investment for domestic development can be found in Theodore Moran. 2002.

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Beyond Sweatshops: Foreign Direct Investment and Globalization in Developing Countries. Washington, DC: Brookings Institution. 4. United Nations Conference on Trade and Development. 2003. World Investment Report. FDI Policies for Development: National and International Perspectives. New York: United Nations. 5. Albert Hirschman. 1945. National Power and the Structure of Foreign Trade. Berkeley: University of California Press. Hirschman argues that outcomes are contingent on the level of asymmetry of power. 6. Robert Keohane and Joseph Nye. 1989. Power and Interdependence. Glenview, IL: Scott, Foresman/Little, Brown College Division. 7. Stephen Jay Kobrin. 1987. “Testing the Bargaining Hypothesis in the Manufacturing Sector in Developing Countries,” International Organization 41: 609–638; Richard Newfarmer. 1985. Profits, Progress, and Poverty: Case Studies of International Industries in Latin America. Notre Dame, IN: University of Notre Dame Press. 8. Ibid. 9. United Nations Conference on Trade and Development. 2001. World Investment Report, 2001. New York: United Nations. 10. World Bank. 2003. Global Development Finance Report 2003. Washington, DC: World Bank Group. 11. World Bank. 2006. Global Development Finance Report 2006. Washington, DC: World Bank Group. 12. Ravi Ramamurti. 2001. “The Obsolescing ‘Bargaining Model’? MNCHost Developing Country Relations Revisited.” Journal of International Business Studies 32, no. 1: 23–39. See also United Nations Conference on Trade and Development. 13. Howard Handelman. 2000. The Challenge of Third World Development. Upper Saddle River, NJ: Prentice Hall. 14. See Quan Li and Adam Resnick, 2003, “Reversal of Fortunes: Democratic Institutions and Foreign Direct Investment Inflows to Developing Countries,” International Organization 57, no. 1: 175–211, for a discussion of the negative attributes of democratic regimes in attracting foreign investment. 15. Steve Chan (ed.). 1995. Foreign Direct Investment in a Changing Global Political Economy. New York: St. Martin’s Press. 16. Adam Przeworski and Fernando Limongi. 1993. “Political Regimes and Economic Growth.” Journal of Economic Perspectives 7: 51–69. See also Eduardo Borenzstein et al. 1998. “How Does Foreign Investment Affect Economic Growth?” Journal of International Economics 45: 115–135. 17. Joan Nelson. 1991. “A Critique by Political Scientists,” p. 275 in Politics and Policy Making in Developing Countries, edited by G. M. Meier. San Francisco: ICS Press. 18. Louis Encarnation and Dennis Wells. 1985. “Sovereignty en Garde: Negotiating with Foreign Investors.” International Organization 39: 47–78. 19. Yi Feng and Baizhu Chen. 1997. “Political Capacity and Private Investment.” In Political Capacity and Economic Behavior, edited by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview Press. 20. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview.

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21. Amartya Sen. 1999. Development as Freedom. New York: Random House. 22. John Maynard Keynes. 1926. The End of Laissez-faire. London: Hogarth Press; John Maynard Keynes. 1933. The Means to Prosperity. New York: Harcourt. 23. Richard Fagen, Carmen Deere, and Jose Coraggio (eds.). 1986. Transition and Development: Problems of Third World Socialism. New York: Center for the Study of the Americas. 24. Jeffrey Leonard. 1980. “Multinational Corporations and Politics in Developing Countries.” World Politics 32: 454–483. 25. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview. 26. G. Garrett. 1990. “Global Markets and National Politics: Collision Course or Virtuous Circle?” International Organization 52: 814. 27. Ibid. 28. Jeffrey Leonard. 1980. “Multinational Corporations and Politics in Developing Countries.” World Politics 32: 454–483. 29. Anthony Smith. 1991. National Identity. Reno: University of Nevada Press. 30. Jeffrey Leonard. 1980. “Multinational Corporations and Politics in Developing Countries.” World Politics 32: 11. 31. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity and Economic Behavior: The Political Economy of Global Interdependence. Boulder, CO: Westview, p. 11. 32. Jeffrey Leonard. 1980. “Multinational Corporations and Politics in Developing Countries.” World Politics 32: 454-483. 33. United Nations Conference on Trade and Development. 2007. Transnational Corporations, Extractive Industries and Development. World Investment Report. New York: United Nations. 34. General Motors Annual Report. 2007. Online at www.GM.com/ corporate/investor_information. 35. Securities and Exchange Commission. 2006. Online at www.sec.gov. 36. John Smith and Richard Wagoner. 2002. “General Motors Automotive Divisions and Operations.” Report. New York: General Motors, p. 3. 37. Ibid., p. 5. 38. Arend Lijphart. 1971. “Comparative Politics and the Comparative Method.” American Political Science Review 65: 682. 39. Ira Katznelson. 1997. “Structure and Configuration in Comparative Politics.” In Comparative Politics: Rationality, Culture, and Structure, edited by Mark Lichbach and Alan Zuckerman. Cambridge: Cambridge University Press. 40. Arend Lijphardt. 1971. “Comparative Politics and the Comparative Method.” American Political Science Review 65: 682–693. 41. Karl Popper. 1991. “Selections from the Logic of Scientific Discovery.” In The Philosophy of Science, edited by Boyde Gasper and J. Trout. Cambridge, MA: MIT Press.

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3 Roadblocks: Ineffective Bureaucracies in Kenya

FOREIGN DIRECT INVESTMENT CAN BE A great asset to African countries. It provides employment, income, capital, technology, and broader integration into the global economy. However, the impetus for foreign investors to locate in deeply impoverished African countries is not intrinsically altruistic. Weak political institutions and desperate economic conditions make African countries vulnerable and dependent, which gives international investors a lot of leverage. Multinational corporations are typically more highly structured, more efficient, and more prosperous than the governments of the African countries in which they invest. In order to address the asymmetrical power relations, governments must develop effective institutions to assert the goals of hosting foreign investment and make policy decisions to support those goals. Africa’s emerging markets, the African Lions, have been relatively successful in strengthening political institutions as a precondition for implementing economic policy. However, most African countries do not qualify as emerging markets; only a few can be characterized accurately as African Lions. The countries that do qualify as emerging markets do not receive much international attention and receive even less international investment.1 Several African countries such as Kenya, Nigeria, South Africa, and Botswana have been successful in establishing beneficial foreign investment patterns, while most others do not demonstrate this capacity. Foreign investment in Africa is primarily in the extractive sector: the natural resource industries of mining gold, copper, cobalt, oil, natural gas, rubber, and diamonds. Even with these valuable resources, the continent of Africa receives only 3 percent of global investment inflows, and FDI has fallen about 20 percent since the turn of the century.2 The

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manufacturing sector has been declining due to lower productivity and higher risk caused by corruption, poor infrastructure, epidemic disease, political turmoil, and violent conflict. There is also the insidious legacy of imperialism. The colonial legacy is evident in the foreign ownership of valuable natural resources and foreign control over manufacturing operations. Representative multinational corporations that are operating in Africa include giants such as Unilever, ConAgra, TotalFina Elf, Dow Chemicals, BMW, AngloGold, De Beers, Coca-Cola, Monsanto, Nike, Kodak, and Del Monte. Foreign investment can be an essential element of Africa’s development strategy, but the strategy is highly contingent on the capacity to negotiate benefits and externalities with multinational corporations.

Investment and Development in Kenya Kenyan politics have been plagued by insurgent and government violence, fraudulent elections, and ethnic clashes. Yet despite the challenges of corruption and ethnic fragmentation, Kenya has continued its transition to multiparty democracy and economic growth. To promote economic growth, the Ministry of Finance has established an Investment Promotion Center (IPC). The IPC is designed to be a “one-stop” agency to expedite the investment process for foreign firms. Large multinational investors in Kenya include Del Monte, Unilever, Williamson Tea, REA Holdings, and General Motors. Most foreign investors in the agricultural sector export tea, coffee, food products, and flowers primarily to western Europe. Kenya’s flower exports recently exceeded those of Holland, Israel, and Colombia. However, the expensive biological testing required by the European Union for agricultural imports is stagnating this sector of growth and investment in Kenya. Other sectors, particularly manufacturing, are struggling to manage and retain foreign investments. The IPC is rushing to coordinate international production and consumption between Kenya and western Europe so that new investment experiments in the manufacturing sector do not collapse. The purpose of examining foreign investment in Kenya is to demonstrate the deleterious consequences of ineffective bureaucracies. The case of Kenya illustrates the importance of strengthening political institutions and clarifying economic policies in order to negotiate effectively with foreign corporations and to manage investments to promote growth. General Motors has been able to extract substantial direct gains in the form of large profits and renewable tax holidays from the Kenyan

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government. It has also been able to make Kenya absorb many of the negative externalities of its manufacturing operations, such as environmental pollution. The Kenyan government has been suffering from fledgling democratic institutions and inconsistent economic policies, which have made Kenya vulnerable to the leverage asserted by powerful multinational corporations. Kenya has been able to gain minimal indirect benefits from foreign investors such as financing for road repairs, aid for disaster relief, and service programs for combating HIV/AIDS. However, the analysis exposes a contrast between GM’s substantial direct gains (revenue) and Kenya’s marginal indirect benefits (aid and service projects). The investment arrangements between Kenya and General Motors will be evaluated systematically using the specific indicators: (1) incentives and constraints—code of conduct, role of investment promotion agencies, regulation of production and consumption, tax policy, labor pool, market access, corruption, discretionary application of policy, transparency in decisionmaking, performance requirements, infrastructure, raw materials, environmental externalities, and other sources of leverage in negotiations; (2) direct and indirect benefits— government revenue, multinational corporate profits, expansion of industrial sector, increase in value-added exports (manufactured goods), new employment, employee benefits (health insurance), skills training, technology transfer, infrastructure development, service provision, financial and humanitarian aid programs; (3) the specific investment arrangements with General Motors that are unique by country case; and (4) the structural change and catalysts for renegotiation that are unique by country case. The same variables are used in each case study. Based on the lessons from GM in these systematic categories, Kenya must focus on institutional development in order to build the capacity to negotiate and manage large multinational corporate investments. The Kenyan government can increase its capacity to attract and utilize foreign investment by demonstrating a credible commitment to democratic accountability, transparency, and nondiscretionary policies on taxation, production, and consumption.

Background and Structural Change Most of Kenya’s modern experiments in political and economic development were initiated by Jomo Kenyatta in the 1960s and 1970s to sta-

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bilize the ethnically and politically fragmented nation. Supporters of Kenyatta credit his presidency with making Kenya “one of the most stable and prosperous countries in Africa.”3 When Kenyatta died, Vice President Daniel Toroitich arap Moi became president through succession and ruled for twenty-five years. Moi’s rule was characterized by contradictions. It fluctuated between fostering and inhibiting democratic development and economic liberalization. In 1982 Moi declared his political party, the majority party Kenya African National Union (KANU), the sole legal party, creating a one-party state. The transition to a multiparty democracy was reattempted in response to domestic demand and international pressure, and competitive elections were held in 1992 and 1997. But the “ethnically fractured opposition failed to dislodge KANU from power . . . [in elections] marred by violence and fraud.”4 The greatest strides toward democratic consolidation were the legalization of alternative political parties and the renewal of a constitutional commitment to elections. The results of these democratic reforms were seen in the December 2002 election. An opposition candidate, Mwai Kibaki, won the election and took office when Moi stepped down in January 2003. The election was hailed as “free and fair” by Human Rights Watch, and constitutes a substantive improvement in the quality of Kenya’s democracy. Historically, Kenya has been held up as a model democracy or a “five star” democracy in Africa. However, it has fallen short of this pedestal until, perhaps, the 2002–2003 elections. The struggle for democracy has generated numerous new political parties, most of which include democracy in their names, and suggests a strong ideological commitment to improving stability and accountability. Democratic ideology can also been seen in the relatively high level of civil society and civil rights, particularly in comparison to most other African countries.

Foreign Investment: Incentives and Constraints The Kenyan government encourages foreign investment. It has made efforts to maximize the incentives for investors and expedite the process of investing. The government established the Investment Promotion Center in 1982 in order to provide a one-stop office for investors and “harmonize investment regimes and investment incentives.”5 The IPC does not impose corporate performance requirements, but it does set minimal standards for environment, health, and security requirements for foreign investments. However, the government has, in large part,

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failed to institutionalize the process of investment. The most substantial problem is that there is no legal code for foreign investment. A code was proposed in the early 1990s to provide legal guidelines for foreign investment, but it is still in draft form. This not only shows the absence of a legal code but also demonstrates the lack of sufficient institutional coherence to get a legal code passed and implemented. Institutional incoherence is also evident in Kenya’s bureaucratic ineffectiveness, which deters investors.6 It is often unclear, even within the IPC, what licenses and permits are required for what types of investments. In addition, Kenya does not record data on the country of origin or the industrial sector of foreign investments. As a result, the Kenyan government has very little information about its own foreign investment, which renders decisions regarding foreign investment uninformed and thus, often ineffective. Foreign investors do have to register with the IPC, so there is information on the overall amount of foreign investment. There are approximately 200 registered foreign companies in Kenya, mostly from the United Kingdom, the United States, and Germany. These foreign investments are screened by the government, through the IPC, to determine their feasibility and potential impact on development. But the approval process lacks transparency. Kenya’s investment process is time consuming, highly discretionary, and vulnerable to corruption. 7 The Kenyan government has periodically made efforts to make the application and selection process clearer and more coherent. However, because there is no investment code, it is difficult to identify to whom the investment process is accountable and what guidelines the IPC follows. The process remains opaque for initiating and renegotiating foreign investment projects. Kenya continues to pursue foreign investment and has focused its efforts on promoting joint ventures between foreign and local corporations. The most attractive investment incentives are the freedom to repatriate profits, a ten-year corporate tax holiday, the recent elimination of foreign exchange controls, and the privatization of utilities and communications. Kenya began most of its liberalization and privatization programs in the 1990s by selling parts of government monopolies to foreign investors. The state held on to a few statutory monopolies such as energy, telecommunications, and media through the 1980s and 1990s and only recently began partial liberalization of these sectors. Kenya also offers additional incentives to invest in foreign free trade zones, referred to as Export Processing Zones (EPZ). There are fourteen EPZs that allow foreign investors unrestricted rights to manufacturing and untaxed imports of equipment and capital. Only six of the EPZs were

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operational in the 1990s and early 2000s, so the campaign to promote FDI has been limited. These initiatives were intended to be a worldwide advertisement of the incentives Kenya provides to foreign investors. Several government agencies have been successful at gaining approval from the legislature in the form of legislative acts and legal contracts that provide extensive incentives to foreign investors. The Foreign Investment Act allows foreign investors to convert currency and repatriate profit at a rate of 60 percent, applicable to all investment across Kenya. This is a reversal of the original restrictions in the 1980s, legislated in the Foreign Investment Protection Act (FIPA), which required foreign investors to apply for a Certificate of Approved Enterprise from the Treasury to repatriate profits and capital. The Manufacturing Under Bond (MUB) and Export Processing Zones Authority (EPZA) have provided an investment allowance of 100 percent on immovable fixed assets, a ten-year corporate tax holiday, exemption from certain industrial and licensing regulations, and guaranteed provision of power and water, and does not require that nationals own any percentage of a foreign company. The Kenyan Revenue Authority claims that these measures are “to maximize revenue collection while providing services consistent with international business expectations.”8 However, the concessions regarding tax breaks and tax exemptions mean that a foreign company can export most of its profits, which minimizes the government revenue gained from hosting the investment. Also, in contradiction to the stated goal of promoting joint ventures, the government requires no inclusion of local businesses or investors in foreign investments. These measures are designed to increase the overall level of foreign investment, but do not contribute substantially to the direct benefits for domestic development. In contrast to the lack of a requirement regarding local business participation, the government does impose labor requirements concerning local and foreign workers in foreign-owned corporations. Employment is the most tangible indirect benefit from foreign investment. The legislature and IPC have worked together to pass guidelines for employment with the objectives of increasing income, obtaining technology, and acquiring more advanced technical skills training. The government has established minimum requirements for health and safety, and a minimum wage for twelve different categories of employees that varies according to the type of job. It is also difficult to get work permits for foreigners and expatriates unless they can demonstrate a high level of education and can provide training to locals. All foreign investors must

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sign a contract with the government, through the IPC, agreeing to offer skills training specifically to nationals. These labor requirements are designed to maximize the employment benefits gained from foreign investment. However, both the US and Kenyan Commerce departments report that these regulations are not followed or enforced. Thus, the value of the rules exists only in the voluntary compliance of foreign investors and in the potential that the government may develop the capacity to enforce the labor requirements. Regarding the capital market, the government began implementing economic reforms in 1993 to make the market more open. It dismantled foreign exchange controls, floated the currency on the international market, removed import licensing, and liberalized the domestic market. This deregulation of the economy is attractive to foreign investors because it reduces restrictions on international and domestic trade, and avoids miscalculations made as a result of distorted currency values. The following year the government also decontrolled prices (except petroleum), which demonstrated Kenya’s commitment to the development of its capital market system. These reforms resulted in an economic growth that peaked in 1995, but it was short lived. As of this writing, Kenya has been in economic decline, which has sparked the return to greater government control and intervention in the economy. In 1996 the government passed legislation to give the Central Bank of Kenya more control over monetary policy and in 1999 implemented a protectionist tariff regime by increasing import duties. The motivation for these nonliberal reforms was not entirely antimarket. Two of the potentially positive results of the reforms are an increase in price stability and improvement in the financial sector. However, until these results are secured, the augmented government regulation of the market will be viewed as counterproductive by foreign investors. Foreign investors consider the Kenyan government to have an “over-regulated” market system.9 Investors are required to get approval from the IPC and comply with a higher tax rate (40 percent) than local firms (32.5 percent).10 Recall, however, that there is an automatic tenyear corporate tax holiday also given through the IPC. Foreign investors must also get technology licenses from the Kenya Industrial Property Office (KIPO). The goal of this requirement is to increase the level of technology transfer and skills training gained from foreign investment. One of the most substantial constraints on foreign investors is that, by law, manufacturers cannot distribute their own products, and they must supply information to the government about their distributors. This is in part to protect state-owned monopolies, but it is primarily for the pur-

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pose of restricting access to domestic markets and protecting local production and consumption. Another factor that has a negative impact on foreign investment in Kenya is corruption. Most underdeveloped countries suffer from corruption, so it is not a source of widespread variation between cases. Corruption does not make Kenya unique. However, it is the unusually high level of corruption that is problematic. The level of corruption is deemed by investors to be such a serious problem that it has become a major reason for widespread divestment out of Kenya.11 Corruption delegitimates government contracts and institutions, and distorts allocation of resources. In addition, politically motivated appointments to ministries, parastatals, and financial institutions, including the Central Bank of Kenya, often render these institutions less effective. 12 The government has publicly acknowledged the need to combat corruption in government and business. An amendment to the Prevention of Corruption Act approved the Kenya Anti-Corruption Authority (KACA) in 1997, which commenced in 1998 but ended in 2000 when KACA was declared unconstitutional. This makes it difficult to argue that the Kenyan government is making a strong effort to fight corruption. Thus, corruption will continue to discourage initial investments, distort current investment procedures and profits, and in the worst cases, corruption will motivate further divestment.

The Effects on General Motors Kenya Limited The Investment Promotion Center focuses its efforts on arranging joint ventures between foreign and Kenyan investors. One example of success is the joint venture between General Motors Corporation, the Kenyan government, and Kenyan investment corporations. General Motors Kenya Limited (Nairobi) was established in 1975 with an agreement that GM would hold the majority of equity and the Kenyan government would partition out the remaining shares. The balance of equity has not changed much over the decades; the sole change is that a Japanese firm has joined in the venture. Currently, GM has a 57.7-percent majority equity interest and management responsibility; Itochu Corporation of Japan has 4.5-percent equity; the government of Kenya owns 20.0 percent through an investment and the Industrial and Commercial Development Corporation (ICDC); and the remaining 17.8percent equity is owned by the Industrial and Community Development Company Investment Company (ICDCIC), a public company and an

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affiliate of the ICDC.13 The venture has been focused on manufacturing Opel, Isuzu, Chevrolet, and multipurpose Isuzu Trooper minibuses; and on assembling Isuzu and Bedford vehicles. General Motors has an active relationship with the Kenyan government and investors, and is routinely renegotiating the cost of infrastructure and inputs. The Kenyan Industrial Development Center has fostered a dynamic automotive sector that has shown consistent growth in manufacturing and assembly. As the size of the industry increases and changes, GM petitions for more access to domestic markets, capital gains tax breaks, and better roads nationwide. Increased market access and tax breaks are regularly awarded. The government does not have much leverage to negotiate in these areas because it has already set the precedent of extended tax holidays and market access. The most interesting and indicative debate concerns who will absorb the costs of improving the infrastructure, specifically the road system. The poor state of the roads is slowly changing demand away from the assembly of new automobiles to the supply of replacement parts and vehicle maintenance. The market for replacement parts is dominated by the Japanese investors in GM Kenya. United States investors and General Motors prefer to pursue the manufacturing and assembly of new vehicles, which are sold throughout Africa, rather than compete with the Japanese replacement parts. General Motors East Africa (Kenya) also exports manufactured automobiles to neighboring countries in the COMESA (Common Market for Eastern and Southern Africa) region: Uganda, Tanzania, Rwanda, Burundi, Zambia, Zimbabwe, Mozambique, and Ethiopia. Thus, the US investors in GM are pressuring the Kenyan government to improve the quality of the roads in the region in order to prevent a change in market demand. Without improved roads, the market will change to increase the demand for replacement parts, the production of which is dominated, as mentioned above, by Japan, not by GM or an American subsidiary. The Kenyan government is banking on the idea that this issue is important enough to GM that if the legislature does not approve additional funding for infrastructure development, then GM will absorb the costs of improving the roads. In the late 1980s and mid 1990s, General Motors began allocating funds to infrastructure development, a large part of which went specifically to road repair. Relatively successful in this regard, the Kenyan legislature has shown that there is leverage in negotiating the costs of infrastructure development. This success demonstrates the potential within the Kenyan government to improve its investment arrangements. It does not, however, overshadow the larger

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reality that Kenya has suffered extensive government ineffectiveness and widespread divestment. In addition to funding small-scale infrastructure projects and road repairs in Kenya, GM has tried to improve its relationship with the government, workers, and communities through its Global Aid program. General Motors Global Operations established Global Aid in 2000 to improve public relations and demonstrate corporate responsibility in many of its foreign locations. Although the aid is minimal (approximately $4 million for Kenya from GM’s tens of billions in international enterprises) and not proportional to the benefit GM extracts from its foreign locations, Global Aid has made several efforts to augment corporate responsibility. For example, GM has been recognized for “outstanding corporate citizenship” by the US State Department for its efforts regarding education, prevention of HIV/AIDS, and disaster relief in developing nations. In the interest of a fair and systematic evaluation of the costs and benefits of foreign investment, the resources GM Global Aid provides to the developing nations in which it invests must be considered and assessed. Global Aid’s priority in Africa is fighting HIV/AIDS, which afflicts GM employees. This assistance is contributed as part of two commitments: GM’s endorsement of the Global Sullivan Principles regarding human rights and GM’s Health and Safety Initiative. Preventing and treating HIV/AIDS is part of the human rights and labor concerns because GM recognizes that AIDS has an impact on the productivity of employees, the workdays lost to illness and disease, the stability of family and community, and the macroeconomic performance of developing countries. GM’s most substantial efforts in fighting AIDS are in South Africa, Kenya, East Africa, and India; and the AIDS outreach programs continue to expand. General Motors invests in preventing AIDS primarily through awareness. GM uses the Center for Disease Control’s (CDC’s) program called Business Responds to AIDS/Labor Responds to Aids to provide employees with education and access to medical services. GM East Africa, including Kenya, provides access to free or affordable antiretroviral drugs to HIV-positive employees and their dependents. In addition to educating and providing medical services to employees, a group of GM volunteers in Kenya and South Africa called HIV/AIDS Busters work to provide the broader community with information. The HIV/AIDS Public Awareness Campaign of GM Global Aid is sponsoring the distribution of the film A Closer Walk, which addresses the relationship between health, human rights, and the harsh realities of AIDS worldwide.

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Global Aid in Kenya has also provided financial aid, albeit minimal, to support disaster relief and affordable housing. In 2004 the GM Global Aid Disaster Relief Fund gave $5,000 to deal with extensive flooding in Nairobi, Kenya’s major urban center. The same year, Global Aid gave a small part of $3.2 million dollars for disaster relief after the tsunami (the epicenter was off the coast of Indonesia) that affected Southeast Asia and Eastern Africa, including Kenya. Most of the money that went to Africa was given by GM through matching funds for employee donations to CARE and UNICEF. General Motors East Africa has also been involved in reducing shantytown or spontaneous housing in Nairobi by contributing funds and volunteers to Habitat for Humanity Kenya and a similar organization called Habitat Build. These public-private partnerships on community projects do benefit development and bolster the public relations of GM at the local level. While certainly beneficial, these contributions to community development programs are minimal. The strategy of using foreign investment to promote domestic development is not based on corporate contributions to small-scale community welfare projects. Rather, it is based on increasing large-scale production, consumption, revenue, and export-oriented industrialization by hosting multinational corporations. The Kenyan government has failed to fully institutionalize the process of investment, develop a legal code for multinational corporations, and enforce the policies of joint ventures. Thus, Kenya has not been able to maximize the benefits and minimize the externalities of hosting foreign investment. There is also a substantial amount of work that needs to be done to improve bureaucratic capacity and combat corruption. The discretionary application of policies, cronyism, and other forms of corruption discourage investors and distort economic functions. Still, the government has been able to assert leverage and negotiate effectively with multinational corporations on a few specific development issues. For example, Kenya has arranged for GM to absorb some of the costs of infrastructure development and road repair. The overall level of positive externalities gained from foreign investment, however, does not eclipse the reality of impoverishment, disenfranchisement, and widespread foreign divestment from Kenya.

Conclusion Since the late 1990s, the struggling democracy of Kenya under Moi’s regime has not been able to substantially increase the level of democracy,

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nor form a more coherent institutional framework. Foreign investors in Kenya have exploited the lack of institutional coherence and accountability by disregarding most of the rules and regulations the government has legislated for foreign investment. Kenya has been more successful in its democratic transition, economic development, and negotiations with foreign investors than most countries in sub-Saharan Africa. The greatest past success in democratic development in Kenya was demonstrated in the 2002–2003 elections, which were the most democratic elections in the nation’s history, and showed the results of the efforts made in the 1990s to improve the level of democracy after its decline during 1987–1990. This moment of democratic development was overcome by the flawed and allegedly fraudulent elections of 2007, which resulted in widespread violence and hundreds of politically motivated killings in early 2008.

Notes 1. Jenny Rebecca Kehl. 2007. “Emerging Markets in Africa.” African Journal of Political Science and International Relations 11, no. 1. 2. Kenneth Mwenda. 2000. “Securities Regulation and Emerging Markets.” Murdoch University Journal of Law, and World Bank 7, no. 1. 3. Robert Opfer. 2002. “Kenya: Country Commercial Guide.” Washington, DC: United States and Foreign Commercial Service, p. 5. 4. Ibid., p.12. 5. Ibid., p. 1. 6. Ibid., p. 5. 7. Norman Miller and Rodger Yeager. 1993. Kenya: The Quest for Prosperity. Boulder, CO: Westview Press. 8. Robert Opfer. 2002. “Kenya: Country Commercial Guide.” Washington, DC: United States and Foreign Commercial Service, p. 1. 9. Ibid. 10. US Department of Commerce. 2002, p. 2. 11. Robert Opfer. 2002. “Kenya: Country Commercial Guide.” Washington, DC: United States and Foreign Commercial Service, p. 2. 12. Ibid. 13. John Smith and Richard Wagoner. 2002. “General Motors Automotive Divisions and Operations.” Report. New York: General Motors.

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4 Corruption: Impeding Pioneer Industries in Nigeria

THE NIGERIAN POLITICAL SYSTEM IS PERVADED by corrupt leadership, volatile ethnic conflict, and widespread poverty. Military and political leaders sporadically disestablish democratic institutions, cancel or annul elections, instigate coups, suspend constitutions, violate civil liberties, and breach contracts. The “Market Research Report” of the United States and Foreign Commercial Service says Nigeria is plagued by numerous interethnic and interreligious disputes, a collapsed infrastructure, and a dysfunctional bureaucracy and judiciary. 1 The most condemning problem, however, is widespread corruption. The democratic deficit and the high level of corruption make it risky for foreigners to conduct business in Nigeria. Most foreign businesses are operating below capacity or divesting, with the exception of multinational oil corporations that are often complicit in and benefit from the corruption. The reason for examining General Motors’ FDI in Nigeria is to expose the debilitating effects of corruption on foreign investment and domestic development. The high level of corruption increases political risk for foreign investors and makes it difficult to grow profitable businesses. Many multinational manufacturers are producing below capacity owing to high operational costs and bureaucratic inefficiencies in which corruption is insidious. Other foreign firms are divesting and leaving Nigeria altogether. Multinational corporations invested in the oil industry are, as mentioned, the exception. Corruption in Nigeria’s oil industry is primarily between the government and complicit multinational oil corporations, which benefit immensely from the collusion. This has an overall negative effect on political democratic development in Nigeria,2 and has had adverse spillover effects on transparency in the manufacturing sector. Foreign investors in manufacturing industries consider cor-

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ruption and political risk in their cost-benefit calculations about where to invest. This is why the case of General Motors in Nigeria is important. Corruption in Nigeria has a dual negative effect: it has a detrimental impact on GM’s productivity and profitability as well as a deleterious effect on Nigeria’s capacity to use foreign investment to generate economic growth. This increases operational costs and decreases profits for GM, and decreases revenue for Nigeria—arguably an overall negative investment environment. The investigation of General Motors Nigeria Limited suggests that Nigeria can decrease operating costs, increase profitability, and reduce risk for foreign investors by improving the implementation of anticorruption policies, which would also generate legal revenue rather than foster dependence on illegal collusion.

Background and Structural Change Nigeria’s tumultuous political history is characterized by disestablishment. The nation experienced a series of coups and military rule for fifteen years, 1983–1998, which disrupted political and economic development. In December of 1983 Major General Muhammad Buhari precipitated a military coup and deposed the elected Shagari government. Buhari suspended the 1979 constitution and disestablished democratic structures. He initiated the “War Against Indiscipline” against journalists, public opinion, and civil liberties. But Buhari’s attempt to consolidate power was interrupted by General Ibrahim Babangida, who overthrew Buhari in a coup in 1985. One of the central changes made by Babangida’s regime was to implement an economic Structural Readjustment Program to open the economy and foster growth. However, Babangida refused most political reforms. He postponed the return to civilian rule, forbade the legalization of any political parties except the government-founded, center-left Social Democratic Party (SDP) and center-right National Republican Convention (RNC), canceled the 1992 presidential primaries, banned leaders of both parties, pushed the date of the election back to summer 1993, and then annulled the elections when they did occur in June 1993. His highest-ranking military officer, General Sani Abacha, imprisoned the president-elect, Moshood Abiola. Babangida soon resigned, “weighed down by sundry problems” and severe economic decline,3 and was succeeded by General Sani Abacha in 1993. Abacha assumed personal control of Nigeria and established an extreme centralized government. He abolished the constitution and

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sponsored extensive executions of the opposition and the press. A violent dictator, Abacha ruled for five years before dying of a heart attack. A Provisional Ruling Council was formed and General Abdusalam Abubakar was appointed chief of state. The council promised to hold general elections to select a civilian government as soon as logistically possible. In May 1999 former general Olusegun Obasanjo won the election as president of the Third Republic of Nigeria, which ended a fifteen-year stretch of military dictatorship. The Third Republic established a new political system and constitution, declaring regular elections and representative government. Now called the chief of state and head of government, the president is elected by popular vote for a four-year term. The new democracy also allows multiple political parties that have been historically excluded or eliminated. These recent democratic reforms suggest an ideological commitment to electoral competition and have improved the level of democratic accountability by holding regular elections and reinstating opposition parties. Overall, however, Nigeria’s political regimes have been nondemocratic, with excessive corruption and extensive domestic conflict, and the legacy persists.

Foreign Investment: Incentives and Constraints Nigeria’s system of investment incentives and constraints is inconsistent and vulnerable to corruption, with the allocation of financial favors and the imposition of regulations often being discretionary. Corruption and discretionary policies mean that considerable time, money, and managerial effort are needed for a firm to begin operating and earning profits in Nigeria.4 The government does offer several tax incentives for foreign investors, arguably to compensate for the difficulty of conducting business in Nigeria. Tax breaks are awarded to “pioneer” industries that promise to increase productivity and technology transfer. In addition, investors who locate in economically disadvantaged areas receive subsidies and tax abatements. Nigeria also has a low-cost labor pool, valuable natural resources (oil), and one of the largest domestic markets in sub-Saharan Africa. However, the country has inadequate infrastructure and widespread social unrest, and the government lacks accountability and efficiency. The poorly constructed and collapsing infrastructure makes it difficult to operate in Nigeria; roads and bridges are crumbling, telephone service is unreliable, and constant shortages of fuel, water, and electricity interrupt production. As a result, business performance is uneven.

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Most resources are allocated to the extractive sector of the economy, which is almost exclusively the domain of petroleum companies. This has left the other economic sectors, particularly the manufacturing sector, in want of sufficient resources to maintain basic operations. The entire manufacturing sector has declined in production and consumption. In contrast to the oil industry, the amount of foreign investment in all sectors combined (manufacturing, agriculture, and service—public and private) has declined in the past decade. Foreign investment outside the oil industry is now less than 2 percent of Nigeria’s GDP.5 Several business endeavors are prospering, but many manufacturers are operating well below capacity, delaying investments, and laying off workers.6 The formalized legal incentives for foreign investors are outlined in four major pieces of legislation and executive decrees: the 1971 Industrial Development Act, the 1986 Industrial Policy of Nigeria, the 1990 Companies and Allied Matters Decree, and the 1995 reestablishment of the Nigerian Investment Promotion Commission. These legal codes are designed to foster the development of particular industries, to encourage firms to locate in economically deprived areas, to promote research and development in Nigeria, and to favor the use of domestic labor and raw materials.7 The Industrial Development Act provides income tax relief to “pioneer” industries, which are foreign and domestic industries that the Nigerian government deems beneficial to Nigeria’s economic development. The selection process for designating a company as a pioneer is unclear and inconsistent. It has been alleged repeatedly by domestic investors and small businesses that the process is highly discretionary. However, the government maintains that its decisions are based on the economic feasibility of investment projects. The 1986 Industrial Policy of Nigeria attempted to clarify and publicize the criteria and benefits. Companies that are given pioneer status enjoy a nonrenewable tax holiday for five years, or seven years if the pioneer industry is located in an economically disadvantaged area. To address allegations of corrupt practices in awarding pioneer status, the 1988 Securities and Exchange Act forbids monopolies, insider trading, and unfair practices in securities dealings.8 The act also imposes performance requirements and transfers of technology from the foreign investments, which are monitored and approved by the government. In 1990 the Companies and Allied Matters Decree required foreign companies to register with and get permits from the Investment Promotions Commission. The role of the IPC was to assure that foreign

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firms would comply with the Nigerian government’s goals for industrialization and economic development. However, foreign investors were also required to register with the Corporate Affairs Commission and the Securities and Exchange Commission, which made the process complicated, time consuming, and inefficient. In contrast, a simpler decree of the IPC was made in 1995 to replace the outdated Enterprise Promotion Act. The decree liberalized the foreign investment regime, allowing 100-percent foreign ownership of firms outside the petroleum sector and deregulating the foreign exchange market. The process of gaining approval from three distinct government agencies in order to make the initial foreign investment, however, remains complex and lacks transparency. In one substantial effort to facilitate foreign investment, the Nigerian government established the Commercial Services (CS) agencies to reduce uncertainty and increase access to information. In 1999 the government created three CS agencies: Market Intelligence, Trade Contacts, and Market/Trade Promotion. The charge of these agencies is to gather and present information regarding Nigerian and international markets, in an effort to expedite the process of production and commerce for foreign investors. The Market Intelligence agency orients foreign investors about market opportunities, ranging from general business environment to product-specific market-entry plans; conducts industry sector analysis; and generates international market research and reports.9 The Trade Contacts office provides a menu of options to identify business partners that meet its qualifications and assists foreign companies in formally presenting their business propositions to local businesses. The Market/Trade Promotion agency organizes and proactively promotes foreign products and services in Nigeria. 10 In addition, because Nigeria is a cash-based economy, the agency coordinates financial exchanges and helps Nigerian banks promote the “smart card” credit card system to businesses in order to decrease the reliance on cash exchanges, especially on the scale of international business transactions and foreign investment. The Free Trade Zones and Export Processing Zones offer another incentive to foreign investors. The Babangida regime established the Nigerian Export Processing Zone Authority to attract foreign investment by allowing free trade and free warehousing of imports and exports in specific regions. However, the zones were not feasible for several years after Babangida’s and Abacha’s administrations, and the premier EPZ in Calabar is still in the process of completion. Over $50 million has been invested in the Calabar port zone, and sixteen firms have provisional

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authority to operate there, but the zone remains mostly nonoperational.11 The government is currently developing a new EPZ for Port Harcort to attract foreign investment and increase exports. These EPZs promise to increase international investment in Nigeria, although the investments will not be secured until the ports demonstrate that they are functional, reliable, and profitable for foreign investors. In contrast to the incentives offered to foreign investors, the Nigerian government also imposes financial constraints. The institutionalized constraints are primarily focused on securing capital and protecting local industries. Foreign investments must be joint ventures and must use Nigerian products and feeder industries to replace as many imports as possible. In 1986, when the national Structural Adjustment Program was established, Nigeria ceased issuing import licenses for the importation of goods in order to maximize the use of local industries and resources. Most of the local businesses and products, with the exception of the oil industry, were not able to meet the needs of new industries and new foreign firms. Thus, in 1989 the National Economic Recovery Fund (NERFUND) provided loans to small- and mediumscale, locally owned Nigerian enterprises related to manufacturing.12 These loans served two purposes: to increase the productivity of small businesses that feed larger industries and to increase the competitiveness of local enterprises. The most restrictive regulations on foreign investment, however, came in 1990 with the Allied Matters Act. According to the act, the establishment of a joint venture by itself is not sufficient to constitute a legal entity. Foreign investors must offer a substantial capital investment, technology transfer, and use of local industry, labor, and resources, all of which must be consistent with Nigeria’s development goals and are subject to government approval. In an effort to secure capital, the act specified that foreign firms cannot operate through a branch office. Potential foreign investors, manufacturers, and suppliers must establish a base of operations and incorporate within Nigeria in order to conduct business. The act was extended in 1993 to specifically require the transfer of telecommunications equipment.13 It also reemphasized the requirement that foreign investors provide technical training to Nigerian workers. The Nigerian labor force is large and inexpensive but remains unskilled. The National Office for Technology Acquisition and Promotion (NOTAP) restated that it was compulsory for foreign investors to have sufficient personnel to train Nigerian workers.14 One of the most substantial regulatory reforms was referred to as “guided deregulation” of the foreign exchange market.15 The changes

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were formalized in the Foreign Exchange Monitoring Decree of 1995, which decreased the amount of overall regulation of foreign exchanges and investments, but increased the level of government monitoring of the process of exchange. The decree also reiterated the emphasis of earlier legislation, such as the Securities and Exchange Act of 1988 and the Allied Matter Act of 1990, which required government approval for investment contracts, and protected local industries. An informal constraint on foreign investors is the lack of transparency in the investment process and regulatory system. Not only are the rules and regulations unclear, but the process of gaining government contracts for foreign investments is inconsistent and varies according to the discretion of individuals in government agencies. The system suffers from “lax and uneven enforcement,” and the collection of taxes and allocation of tax breaks are “highly uneven, arbitrary, and non-transparent.” 16 These offenses were most prevalent during the Buhari, Babangida, and Abacha regimes. Military leaders in government positions and the administrators who worked under them were notorious for making discretionary decisions regarding the regulatory system, as well as for keeping the process complex and opaque. After the Abacha regime ended, the Obasanjo government established panels to review all contracts awarded by the previous governments. In 2000 the government enacted the Corrupt Practices and Other Related Offenses Act. But it will take many years to accurately identify and correct the financial irregularities from earlier regimes. It will take even longer to convince the international investment community that the investment environment is less corrupt and more consistent.

The Effects on General Motors Nigeria Limited (Lagos) The confusion and inconsistency of Nigeria’s foreign investment regulations have affected the country’s capacity to manage General Motors’ investment. The corporation has been able to choose what regulations it will or will not follow. General Motors Nigeria Limited has complied with the government’s requirement that investments be joint ventures with Nigerian firms. Accordingly, GM increased its Nigerian operations substantially in 1991 with a joint venture between GM Nigeria (Lagos) (mergers and acquisitions of Federated Motors Industry and Niger Motors) and GM Corporation Detroit, USA, which controls 60 percent. General Motors has also benefited greatly from its “pioneer” status and the privileges awarded by the government to pioneer industries, although

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the status and privileges are almost exclusively handed out to the oil sector. General Motors Nigeria Limited assembles and sells vehicles to general consumers, but GM is most successful at supplying specialized and adapted vehicles (Isuzu pickups and Chevrolet trucks) for applications in the oil sector. This is primarily because the majority of industrial production, “pioneer” privileges, and wealth to purchase vehicles is, obviously, in the oil sector in Nigeria. However, Nigeria has not been able to maximize its benefits from the GM investment owing to its inability to articulate and enforce the government’s foreign investment policies. Further, General Motors has not had to comply with the performance requirements, domestic labor and resource requirements, capital reinvestment, or technology transfer and skills training for employees. The compliance with the joint venture requirement dates back to GM’s original investment in Nigeria. General Motors business operations in Nigeria date back to 1927, when United Automotive Corporation of Nigeria Limited (UACN) of Lagos began marketing GM vehicles, specifically Chevrolet kitcars, Bedford trucks, and Vauxhall, Buick, and Chevrolet passenger cars. The success of these sales in the entire African region encouraged General Motors to build an assembly plant in Nigeria. In 1965 GM bought the Nigerian Vehicle Assembly Plant and transformed it into the Federated Motors Industry, which was a joint venture between GM and the Nigerian government. Vehicles were locally assembled from “knocked down” parts to complete the imported “fully built units.” General Motors applied to the government for pioneer status in order to receive substantial tax breaks for the assembly. The plant was granted official status as a progressive manufacturer of commercial vehicles in 1979 and received almost complete tax exemptions.17 Since compliance with the joint venture requirement is one of the only policies the Nigerian government has been able to secure, it has constituted the main focus regarding the GM investment. The regulation was reevaluated in 1991 when GM expanded the assembly operations into the larger production operation called General Motors Nigeria Limited. The corporate expansion was approved by the government, with General Motors holding 30-percent equity, UACN acquiring 60percent equity, and the employees being allotted 10-percent equity.18 In exchange for compliance with the joint venture regulation, GM received more access to the automobile market in Nigeria and Africa and fewer taxes on the distribution of 1,500 commercial vehicles annually in Nigeria.19 General Motors also added Isuzu TFR pickups, medium-duty trucks, and body building of special-purpose vehicles to its Nigerian production lines.

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This trade-off—larger tax breaks and access to more African markets in exchange for joint ownership between GM and the Nigerian Automotive Corporation—did not maximize the benefits for Nigeria. The inability of Nigeria to enforce any other investment policies except the joint ownership policy, means that General Motors has not had to comply with the performance requirements, domestic labor and resource requirements, capital reinvestment, or technology transfer and skills training for employees. For example, one of the performance requirements states that GM would use as many domestic resources as possible in exchange for its contract to operate in Nigeria. However, Nigeria has not been able to provide sufficient domestic resources, and GM has had to finance most of the infrastructure necessary to maintain and increase production. It has had to absorb the costs of repairing roads, extending electric lines and water pipes, and acquiring energy from external sources. General Motors has also claimed these infrastructure investments as tax exemptions although there is no legal provision for this exemption and GM already has minimum tax status. 20 This has led GM to disregard other performance requirements because there is no exchange of benefits nor enforcement of the regulations. For example, it has not actively engaged in technology transfer or technical training of employees as established in the Allied Matters Act, and the Nigerian government has not been able to enforce compliance with these policies. General Motors has tried to demonstrate corporate responsibility through the GM Global Aid program. Yet even the activities of Global Aid are minimal in Nigeria. In conjunction with General Motors Nigeria Limited, Global Aid gave thirty annual scholarships to attend Nigerian universities and thirty annual scholarships to attend secondary school through the Secondary School Scholarship Scheme to children of GM Nigeria employees. However, funds to fight HIV/AIDS, build lowincome housing, or provide disaster relief for environmental damage, as given by Global Aid in Kenya, are noticeably absent in Nigeria despite widespread environmental externalities from the extractive and manufacturing sectors. The government has not demonstrated the capacity to hold GM accountable for the negative outcomes, and in some cases the government is even complicit in creating or allowing these externalities.

Conclusion General Motors is functioning below capacity in Nigeria. The overall cost of production remains relatively high due to low capital expendi-

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tures by the Nigerian government, which perpetuates poor infrastructure, insufficient electricity, high energy costs, and high exchange rates. General Motors has compensated for this by developing roads and power grids itself, and deducting twice the expense from what it owes Nigeria in tax revenue. However, the primary concern of General Motors in Nigeria during the past few years has been a new discretionary tax referred to as Technical and Commercial Service Fees that lowered GM profits by almost 58 percent between 2004 and 2005. The tax was not applied during the prior fiscal year 2003/2004, has not been applied since, and may or may not be applied again in the future. Of course, there is no evidence that the additional tax revenue was intended to be invested in infrastructure development or standard of living; most likely, the discretionary tax revenue was lost in the abyss of corruption. Nigeria has experienced twenty years of sporadic coups, military rule, and collusive corruption. Its political institutions have been characterized by discretionary decisionmaking, and economic liberalization has been limited in order to protect the oil industry. Foreign investors outside the oil industry have not had to comply with foreign investment regulations owing to a lack of enforcement capability and accountability. It is this lack of accountability as well as the discretionary application of economic policy that makes foreign investment a risky endeavor in Nigeria.

Notes 1. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 9. 2. Michael Ross. 2001. “Does Oil Hinder Democracy?” World Politics 53 (April): 325–341. 3. Henry Ugbolue. November 1, 2001. “Babangida Quits.” The News (Lagos), p. 1. 4. Ibid., p. 43. 5. World Bank. 2002. Global Development Finance Report 2002. Washington, DC: World Bank Group. 6. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 4. 7. Miguel Pardo de Zela. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 44. 8. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 6. 9. Ibid., p. 4. 10. Ibid.

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11. Miguel Pardo de Zela. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, pp. 41–49. 12. Toyin Falola. 1999. The History of Nigeria. Westport, CT: Greenwood Press. 13. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, pp. 15–23. 14. Ibid., p. 7. 15. Miguel Pardo de Zela. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 51. 16. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 12. 17. John Smith and Richard Wagoner. 2002. “General Motors Automotive Divisions and Operations.” Report. New York: General Motors. 18. “America’s Competitiveness.” August 8, 1991. Wall Street Journal, p. A3: 6 19. “Selection of the IHRO Report.” August 8, 1991. New York Times, p. D4: 4. 20. Dillon Banerjee. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, pp. 15–23.

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5 Growing Pains: Securing the Benefits of High Tech Investment in India

THE OPENING OF ASIAN ECONOMIES AND the implementation of export-oriented industrialization have demonstrated Asia’s commitment to economic growth. As part of the growth strategy, many Asian countries have made a full-scale effort to attract foreign investors. India has helped fund and promote several High Tech City locations to meet the expectations and interests of multinational corporations. High Tech Cities are large, modern buildings similar to what you would find in a US research park or business park. The buildings have state-of-the-art business centers with computer technology, advanced telecommunication services, and reliable energy supply, which is a primary concern to any business investment in computer services. India’s High Tech City in Hyderabad has three energy-supply backups to avoid power loss and computer crashes: two separate power sources that are independent of the city’s power grid and a backup generator. The High Tech City also has an emergency flight plan so that if all three power sources fail, the employees can be flown to the nearest High Tech City where the energy supply has not been interrupted. India has also developed its skilled labor force to attract investors. It founded “Millionaire University” (Indian Institute of Technology) as an investment in human capital, higher education, and technical training. Yet the cost of the labor in India is relatively low. These capacities—reliable energy and skilled labor—appeal to foreign investors, and thus India is the recipient of many outsourced jobs in the information and communication technology sector. Most Asian countries have used state planning and government management of the economy, including production and consumption quotas, to promote growth. Several Asian governments have even deter-

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mined the comparative advantage of their economies, rather than letting the comparative advantage emerge organically. India and Malaysia, among others, have declared that high-end consumer electronics and telecommunications technologies will be their comparative advantages. The governments have acted accordingly to bolster those industries. Governments have actively invested in higher education centers such as “Millionaire University” in India; technical training centers such as “General Motors University,” with in-residence classes and 2,200 online courses; subsidies for technology and telecommunications sectors; protections for domestic infant industries; and financial incentives for foreign investors. Asia is not risk free for foreign investors. The region is plagued with political instability and socioeconomic unrest. Train bombings targeted business commuters in India’s largest urban area and international business mecca, Mumbai, killing several hundred commuters in the summer of 2006 and several dozen in the winter of 2007. China is suffering an energy crisis. Indonesia has recurrent violent conflicts, secessionist movements, and terrorist attacks. Thailand had an unexpected coup that was successful with minimal resources and almost no firepower. Bangladesh has evacuated its capital city several times recently, owing to violent conflict surrounding contentious elections. Burma experiences almost constant upheaval. The memory remains of the rise of the Asian Tigers, but the memory is tainted with the reality that it was unsustainable and ended with the 1997 Asian Financial Crisis.

Foreign Investment and Development in India India is a burgeoning economic powerhouse. It has proven to be competitive internationally and has achieved remarkable economic growth. The primary economic development strategy has been to liberalize industrial policy and attract large foreign investments in information and communication technology. High-profile multinational corporations such as IBM, Nokia, Citibank, Nestlé, Royal Dutch Shell, BP (British Petroleum), Afro Asian Satellite Communications, Mitsui, PowerGen, General Electric, and General Motors have made substantial investments in manufacturing, telecommunications, service industries, and energy in India. The Indian economy continues to attract foreign investment inflows, increases global trade, performs well, and promises good long-term prospects. The Indian government has implemented a deliberate development strategy of improving the investment environment and

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increasing integration in the global market, and has been able to sustain economic growth rates between 6 and 9 percent for over fifteen years. However, there are concerns of inadequate infrastructure and political instability that increase risk for foreign investors. India suffers periodic political unrest and violent conflict. Several foreign investment buildings, industrial campuses, foreign firms, foreign infrastructure projects, and foreign installations have suffered politically motivated attacks. There are also violent attacks on Indian citizens, particularly those professionals who work in the modern business sector and the working-class employees who provide support services to the private sector. The train bombings during rush hour in Mumbai in the summer of 2006 and the winter of 2007 were specifically targeted at commuter traffic. The series of six bombings in 2006 killed hundreds of workers and terrorized commuters for many weeks, causing a measurable work slowdown and loss of productivity in Mumbai. There are also ongoing conflicts with Kashmir and Pakistan, but the state and federal governments have tried to respond decisively in those disputes to avoid escalation. Another major obstacle to attracting and retaining foreign investment is India’s inadequate infrastructure. Although improvements have been made in urban areas to attract foreign investors, India is still plagued by erratic energy supply and power outages, unreliable water supply, extensive pollution, inconsistent and clogged transportation infrastructure, and urban health and sanitation problems related to high population density. The purpose of investigating India’s arrangements with General Motors is to identify successful strategies for attracting and utilizing foreign investment to achieve rapid economic growth. The Indian government has made deliberate decisions about the trade-offs in costs and benefits of hosting foreign investment, and has succeeded in facilitating profits for foreign businesses and generating revenue for domestic government. However, the hidden costs and externalities for India are quickly being exposed. There are consequential contradictions in India’s large labor pool and small tax base; democratic political system and widespread human rights abuses; high profitability of foreign firms and growing domestic economic inequality and political instability. The relatively strong institutional framework has made it possible for India to negotiate mutually beneficial investment arrangements with multinational corporations, including General Motors. But the institutional framework has underlying inconsistencies that jeopardize the balance of benefits and threaten internal stability.

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Background and Structural Change India is the world’s largest democracy. It is recognized as a success story for its development of a functional, democratic system of federalism to unify one of the most ethnically diverse populations in the world. The federal government maintains the responsibility of managing the macroeconomic and macropolitical environment through incentives and constraints that promote economic growth for the country as a whole. The regional governments help implement national economic policy, articulate and advocate regional interests, and incorporate local-level decisionmaking. The balance of national and regional authority has fluctuated since independence and partition in 1947; there are ongoing disputes regarding Kashmir and Pakistan, which have caused three wars in the past twenty years. The federalist system is designed to balance the power of the national government with the autonomy of the states. The prime ministerial post and executive power have been alternating between the Congress Party—part of the political legacy of Mahatma Gandhi and Indira Gandhi—and the Bhartiya Janta Party (BJP), which has a conservative wing and a radical wing. Prime ministers Mahatma, Indira, and Rajiv Gandhi prioritized poverty reduction and worked to re-create the Indian economy after the economic ruin, political instability, and bloody transition to partition, but they were all eventually assassinated by the political opposition. When Prime Minister P. V. Narasimha Rao took power in 1991, he emphasized the need for liberal economic reforms and the “opening” or integration of India into the global economy. Rao’s finance minister and chief economic consultant was Manmohan Singh, who was a former International Monetary Fund (IMF) official and the governor of India’s Central Bank. During this time, the BJP became the plurality party in control of the Parliament. Prime Minister Atal Behari Vajpayee of the BJP was elected in 1998, but the BJP plurality in the Parliament was not sustainable. The BJP lost a vote of no confidence in the spring of 1999, and the Parliament had to be dissolved. Policy proposals and investment decisions were postponed for a year until a governing coalition could be rebuilt. During the coalition reconstruction, Prime Minister Vajpayee called for reforms to improve the investment climate, reduce bureaucracy, implement World Trade Organization (WTO) policy, and to improve corporate governance by increasing efficiency and accountability. The reforms were well received by the new coalition government as well as international investors. But the radical wing of the BJP committed

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numerous terrorist attacks on Indian politicians, business leaders, and foreigners, especially Westerners, and the BJP was ousted from its plurality. The Congress Party regained control of the Parliament and Manmohan Singh of the Congress Party became prime minister in 2004. Recall, Singh was previously the finance minster, an IMF official, and the driving force behind Rao’s economic liberalization. Singh has predictably continued the liberalization, implemented market-friendly reforms, pursued foreign investment, and in 2006 initiated a plan for rural job development, promising to employ approximately 60 million Indians in rural areas. Recently, there has been a resurgence of the small radical wing of the BJP, which has engaged in politically and economically disruptive behavior, including terrorist attacks in India. The political instability caused by the BJP and other insurrectionary groups is alarming and can deter foreign investors. Countermeasures have been taken to limit the violence and to reassure foreign investors that the Indian government will minimize political risk. However, sporadic incidents of political violence, such as the bombings in Mumbai previously mentioned, continue to register in the decisionmaking calculus of potential foreign investors. Foreign investment and trade with the United States was temporarily interrupted after India’s nuclear tests in the spring of 1998 and the intermediate-range ballistic missile tests in 1999. The United States imposed sanctions on the operations of the Export-Import Bank, Trade and Development Agency, and Overseas Private Investment Corporation in India for over a year. Since the restrictions were lifted, the investment and trade relationship between the United States and India has grown almost exponentially. Billions of dollars of foreign investment and trade flow between the United States and India annually, and tens of thousands of jobs are outsourced to India. It has proved to be a prime destination for foreign investment.

Foreign Investment: Incentives and Constraints The Indian government has promoted liberalization of trade, standardization of policy, and privatization of industry. It has also facilitated international investment by creating the Foreign Investment Promotion Commission (FIPC) in 1997 to simplify investment procedures, consolidate bureaucratic processes, and advertise the automatic approval policy for foreign investment. The FIPC has tried to establish itself as a “one-

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stop shop” for foreign investors. It facilitates automatic approval for foreign investment in high priority industries such as manufacturing and telecommunications, and automatic approval for direct investment in electricity generation, transmission, and distribution; roads and highways; vehicular tunnels and bridges; and ports and harbors.1 The automatic approval process for foreign investment is a clear indication of India’s commitment to an open economy, international investment, and global trade. The Indian government and FIPC deliberately pursue foreign investment in information, communication, and computer technology. India has previously focused on agriculture and textiles but is trying to establish a comparative advantage in high-end telecom service and technology. The Indian government and FIPC subsidize the construction of High Tech City buildings to attract foreign investors by providing comfortable facilities with advanced technology capacities and reliable energy sources. India welcomes investment from international financial institutions such as the World Bank and USAID, which finance numerous infrastructure and energy projects in India that are intended to attract foreign direct investment in the private sector. There is internal concern about the amount of FDI in infrastructure projects, and the loss of sovereignty in policymaking regarding domestic development. Many local politicians and business leaders demand that India be built by Indians.2 The Indian government has declared that national and local leaders should not antagonize foreigners. 3 In exchange for local leaders’ cooperation, the federal government will work to extract domestic benefits from foreign investment and use the revenue to address the country’s socioeconomic needs. India has coherent objectives for its negotiations with foreign investors. The government bargains to establish mutually beneficial investment arrangements, and it has the institutional capacity to monitor and enforce many of the arrangements. The FIPC negotiates automatic approval for foreign companies that agree to follow the corporate governance laws of India and to provide direct investment in sectors deemed high priority, such as telecom, energy, manufacturing, and infrastructure. The benefits for India are technology transfer, energy access, skills training, employment, tax revenue, and better integration into the global market. To assure the mutuality of the benefits for India, the government is revising the Companies Act that governs commercial practices for companies operating in India.4 Despite the obvious benefits of coherent institutions and a legal framework, problems are emerging because India continues to over-regulate business. A large bureaucracy asserts discre-

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tionary powers in political and economic decisions. Foreign investors view discretionary decisionmaking as a threat to predictability, and riskaverse investors will not respond favorably. Transparency in decisionmaking, as opposed to discretionary decisionmaking, is essential for foreign investment. Unfortunately, US firms report that bureaucratic discretion and corruption are still the largest impediments to doing business in India.5 There are policies and laws in place to prevent corruption: the Prevention of Corruption Act, the Companies Act, and the Code of Criminal Procedures. The implementation of these policies, however, has varied widely. Paradoxically, the telecommunications and energy sectors—the sectors the Indian government is trying to promote—have the most documented cases of corruption. The government is trying to revise and build capacity to enforce the anticorruption policies more consistently. India has a higher institutional capacity in general than many developing countries, and it has the institutional capacity for dispute settlement in the judiciary. Initiating many investigations into political and business corruption, the judicial branch has found numerous politicians, bureaucrats, and business leaders guilty under anticorruption laws.6 The legal institutions are failing, however, to be completely transparent themselves, reiterating the general concern about discretionary decisionmaking. Yet government and legal institutions have demonstrated the capacity to protect property rights and contractual rights, which are crucial to foreign investors. India’s skilled labor force is an incentive for foreign investors. India holds the world’s third-largest pool of science, telecom, computing, and technical labor,7 and most of the skilled labor force is unemployed or underemployed. Foreign firms can hire competent, technically trained labor at a relatively low cost. A counterweight to this incentive, however, is that foreign firms cannot fire workers without the permission of the government. The Indian government imposes this labor requirement to insulate or protect its skilled workforce from market volatility and, arguably, to make it difficult for investors to divest. To maintain the draw of the skilled labor force despite regulatory constraints, the Indian government has promoted and financed higher education in information and communication technology. The government founded the Indian Institute of Technology that students have coined “Millionaire University” because it has produced many millionaires in its short history. The attention given to India’s elite educated labor, however, should not overshadow the majority of Indian workers who are easily exploitable because they are unskilled and undereducated. This is

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important to foreign investors, particularly in manufacturing, because marginal illiteracy and language barriers decrease productivity. There is an incongruity between India’s large labor pool and its small tax base. India does not have a broad income tax base. If it expanded the income tax base, it would be taxing a desperately poor population. The Indian government has a policy not to tax citizens who make less than $2,500 per year. In part, the poor are not taxed in accordance with a political philosophy of and civic commitment to social justice. Many countries have a similar policy. The United States, for example, does not require that people file taxes if their income falls below the poverty line. The important distinction in the case of India is that approximately 75 percent of its population falls below the poverty line—below the $2,500 per year income bracket—which thus excludes this sizable majority of the population from the tax base. In addition, taxing people who make less than $2,500 a year would drive people further into poverty, leaving them with even fewer resources to dig themselves out, which would hinder growth and development in the long term. Regardless, the big bucks in India would not come from taxing the poor population but would, theoretically, come from taxing the business elite and the multinational corporations. The tax rate for foreign companies in India was reduced from 55 percent to 41 percent during 1997–2000,8 which is still comparatively high. Yet multinational corporations continue to herd into India. To compensate for the high tax rate, India has reduced the final tax incidence for forty countries, including the United States and Japan, as well as the European Union. Proposals are made fairly regularly to reduce the tax rate for foreign investment, but the government of India (GOI) reports that the tax compliance of foreign investors is alarmingly low. Corporate tax evasion is widespread in India,9 by domestic and foreign firms. The GOI argues that tax compliance must be improved before corporate tax rates can be reduced. The government is trying to increase accountability and transparency by streamlining the tax regime and replacing the complex tax code.10 In addition to a clearer and more concise tax code, the government is offering relatively new tax incentives to foreign investors. A five-year tax holiday is available to businesses that contract for infrastructure development projects, and a ten-year tax holiday is awarded to companies that locate in free enterprise zones. India has established three types of free enterprise zones to attract foreign investment: Export Processing Zones (EPZs), Free Trade Zones (FTZs), and software technology parks (including High Tech City buildings). The FTZs are designed to be state-of-the-art, high tech facilities

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that have overcome the typical infrastructure problems in India. Access to energy and access to computer technology are good examples. Foreign investors are deterred by the sporadic loss of electric power in India, which can crash computers and halt business. To be attractive to foreign investors, India must have consistent access to electricity, running water, computer technology, transportation, and communication. The FTZs provide this infrastructure, including such previously mentioned safeguards as independent power grids, backup generators, and flight plans to move employees to the nearest operational business facility if the two other energy sources fail, as mentioned. The government finances the development of FTZs in order to encourage foreign investment, and it has succeeded in this endeavor, as evidenced by the outsourcing of high tech, computer, and telecommunications jobs to India. India does not impose performance requirements on foreign firms, does not require joint ventures with Indian firms, does not require employment quotas, and does not have controls on the repatriation of profits, which is appealing to foreign investors because they take as much of their money out of India as they choose. There are a few exceptions to this liberal policy, one of which is a crucial exception for the study of manufacturing investments. India maintains its regulations and constraints on the automotive sector, along with constraints on entertainment and food industries. In 1997, when India was at the height of its economic liberalization strategy, the Indian Cabinet on Economic Affairs added new rules to “all new foreign automobile manufacturing investments in India.”11 Automobile manufacturers must sign a memorandum of understanding with the government to indicate that the firms accept and comply with the requirements for the automotive sector. The new regulations include joint ventures with Indian firms, restrictions on access to local markets, export requirements, labor requirements, and limits on the repatriation of profits. While not deterring foreign investment, the new policy constraints have had substantial implications for the investments and operations of the automotive sector.

The Effects on General Motors India Private Limited General Motors’ success in India mirrors the growth of the Indian economy as well as contributes to it, foreign investment having been an engine of growth for India. Access to India’s growing consumer base and skilled labor pool has also been profitable for foreign investors. General Motors has had great success in negotiating advantageous

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investment arrangements with the Indian government. A new terminology has emerged to describe GM’s success, as in “the Chevrolet Indian Revolution,” and GM has won ten prestigious industry awards, including Car Manufacturer of the Year and Marketing Team of the Year. The marketing campaign has been so successful that experts claim General Motors has generated a “blooming love affair between the Chevy and India.”12 The love affair is not without its rocks, however, and GM and India have renegotiated their relationship numerous times. General Motors India Private Limited was incorporated in 1994 as a 50-50 joint venture with Hindustan Motors, which became part of the Birla Group of India. It renegotiated the investment arrangements in 1999 and became 100-percent General Motors USA. Since then, GM has achieved 70–90 percent growth every year for almost a decade in India. The Foreign Investment Promotion Commission of India and General Motors have negotiated several distinct investment arrangements, some of which contradict the constraints established by the Indian Cabinet on Economic Affairs and its new rules for foreign auto manufacturers. General Motors has negated the new rules regarding joint ventures in the auto-manufacturing sector but has complied with new labor requirements. When GM restructured its joint venture arrangements with Birla Group, the government required GM to sign a memorandum of understanding that GM would bring an additional US$50 million in foreign equity to India. To challenge this requirement, GM claimed that its joint venture partner should be required to contribute an equal amount of equity. Because Birla Group did not have the capacity to match GM’s contribution, the Indian government reduced GM’s requirement to $10 million over three years rather than $50 million in one year. After “protracted discussions between the company and commerce ministry,”13 General Motors managed to alter the incentives and constraints in its favor and negate the national auto policy in India, which requires foreign firms to sign a memorandum of understanding (MoU) with the Directorate General of Foreign Trade. Only eight MoUs have been signed in approximately ten years. Another substantial investment negotiation occurred between GM and the Maharashtra state government. The Maharashtra Industrial Development Corporation negotiated a US$300 million investment deal with GM in which the latter agreed to hire 1,000 India workers and Maharashtra state agreed to give GM a 95-year lease on the property for its Telegaon plant. General Motors presented its $300 million investment arrangement as a show of credible commitment to India and Third World development. The award-winning marketing team articulated the

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deal thusly: “In demonstration of our commitment to India, we have invested in the expansion of our existing manufacturing facility in Haloi and begun work on a greenfield plant in Telegaon, Maharashtra.”14 It is not shocking that GM’s commitment to India is actually based on profitability, skilled low-cost labor, and access to one of the largest consumer markets in the world, rather than on altruistic intentions to modernize India or the Third World. Regardless, the Indian government supports GM’s ambitions and bottom line because it wishes to attract more foreign investment. As Chief Minister Vilasrao Desmukh remarks, “The State will extend its full support to GM’s new plant to ensure that it becomes a success.”15 The Indian government has allowed General Motors to assert leverage and win concessions in several negotiations because there are longterm benefits to GM being highly profitable in India. Chief Minister Desmukh goes on to explain: “The presence of GM reaffirms Maharashtra as a leading investment destination. It will encourage other multinational and Indian companies to consider Maharashtra for their ventures.”16 In addition to attracting general foreign investment inflows based on GM’s success, India is specifically interested in acquiring foreign investments from GM’s information technology (IT) suppliers. In 2006 GM awarded US$15 billion in contracts to IT service providers.17 The $15 billion in contracts went to multinational IT corporations, including Hewlett-Packard, Capgemini, IBM, Compuware Covisint, and Wipro. If GM does well financially in India, which seems likely, GM may encourage its IT suppliers to move there as well, and to move their $15 billion contracts with them. Wipro is already an Indianbased multinational company, but the additional foreign investments of GM’s other IT suppliers would fit well with India’s broader development strategy. In addition to bringing its suppliers to India, General Motors has made efforts to increase corporate responsibility. GM’s Global Aid in India has been less active than in other GM locations. It has, however, stepped up in a few cases to support disaster relief and address the housing crisis. Global Aid contributed US$47,000 and four vehicles to India through the Southeast Asia Disaster Relief Fund, and contributed to the Roundtable on South Asia Earthquake Relief. 18 Global Aid has also helped to alleviate the housing crisis by building shelters for the poor near the GM Technical Centre outside of Bangalore. This makes only a small dent in the situation’s resolution considering the size of India’s population and the magnitude of the housing crisis, but it is a dent, nonetheless, and it is important that Global Aid pursue these endeavors

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without being required to do so by anything other than public relations, albeit self-interested. The acute water shortage in India is an ongoing problem that should receive more attention and financing by Global Aid. General Motors in India has to buy water and transport it from the Narmada Canal in order to sustain its operations. At this point, GM’s only water concerns are limited to its production capacity; its water use has increased almost 30 percent every year in India, owing to increased production.19 In the near future, GM will have to pay a higher price for this increasing water use—a higher price in terms of operating costs and public relations. Although Global Aid has no jurisdiction over operating costs, it can have an impact on public relations. To maintain positive public relations, Global Aid will have to make amends for GM’s increasing water use in a country that is verging on a water crisis, or Global Aid will have to develop programs to conserve water in GM industries. Global Aid in Mexico has dealt with a similar water shortage and has been relatively successful in improving public relations on the issue of water conservation. Global Aid in India would do well to implement the strategy it used in Mexico. Otherwise, GM’s use of increasingly scarce water resources will become even more contentious and could spark violent conflict, and certainly will spark volatile public relations. The fact that GM Global Aid is, in part, a mechanism to support GM’s industrial operations by fostering positive public relations should not be surprising. General Motors mobilized positive customer-product relations to generate the “blooming love affair between the Chevy and India,”20 from which GM profited greatly. The Indian government has tried a similar “marketing” technique to attract foreign investors. The government has financed large, high tech office buildings to attract foreign investors and has advertised the capacity to provide alternative power sources to correct for India’s frequent power outages. Although this capacity has not substantially increased India’s leverage to negotiate, because foreign firms would not invest in India at all if it could not compensate for regular power outages, India can compete with other developing countries whose governments do not have the capacity to supply sustainable energy sources. While this provides insight into why investors might choose India over Kenya, the question remains, how do investors choose between India and China? The decisionmaking calculus, with respect to this question, should not be oversimplified, but the Indian government has the capacity to monitor business practices in consolidated business parks and the accountability mechanisms to enforce a modicum of corporate responsi-

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bility. In contrast, China is suffering an international public relations crisis regarding its capacity to monitor and enforce production requirements such as the level of poisonous lead in children’s toys and the amount of toxins in food products that are exported. The consequences of this problem have yet to be played out fully, but they will damage the leverage of China and increase the leverage of multinational corporations to negotiate investment arrangements. This is expected, according to the theory of this research, because it increases the level of risk for foreign investors. If the level of risk is high, foreign investors will require China to compensate them heavily for absorbing the risk. The heightened risk, as well as China’s decreasing capacity to secure energy sources, will make China a fascinating case for the extrapolation of this research.

Notes 1. United States and Foreign Commercial Service. 2000. Country Commercial Guide: India. New Delhi: US Embassy India. 2. Ibid. 3. Ibid. 4. US Embassy India, Bureau of Economy and Business Report. 2006. New Delhi: US Embassy India, p. 144. 5. US Embassy India, Embassy Investment Survey. 1999. New Delhi: US Embassy India. 6. US Embassy India, Bureau of Economy and Business Report, p. 147. 7. International Labour Organization, Bureau for Workers’ Activities. 2007. “Geographical Distribution of Largest Companies.” Geneva: International Labour Organization. 8. United States and Foreign Commercial Service. 2000. Country Commercial Guide: India. New Delhi: US Embassy India. 9. Ibid., p. 5. 10. Ibid., p. 145. 11. Ibid. 12. Sandeep Raj Singh. January 29, 2007. “General Motors India on a Roll,” Company News, New Delhi, General Motors India, p. 5. 13. General Motors. 2007. India News. Annual report, “Global Operations: India.” New Delhi: General Motors. 14. Sandeep Raj Singh. January 29, 2007. “General Motors India on a Roll,” Company News, New Delhi, General Motors India, p. 5. 15. “General Motors to Invest $300 Million in Maharashtra Car Plant.” August 4, 2006. The Hindu: India’s National Newspaper. 16. Ibid. 17. Mary Hayes Weier. February 2, 2006. “GM Awards $15 Billion in IT Services,” Information Week.

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18. General Motors. 2007. Global Aid. Annual report, “Global Operations: India.” New Delhi: General Motors. 19. Ibid. 20. Sandeep Raj Singh. January 29, 2007. “General Motors India on a Roll,” Company News, New Delhi, General Motors India, p. 5.

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6 Joint Ventures: Developing a Business Class in Malaysia

THE MALAYSIAN GOVERNMENT HAS CREATED A unique balance of

market freedom and government intervention, nondemocratic and democratic institutions, and incentives and constraints on foreign investment. The government has taken an active role in the process of domestic political and economic development. It has, at times, condemned the global capitalist market while also participating in it. Prime Minister Mahathir bin Mohamad remarked to an international journalist that the global capitalist market is “a jungle of ferocious beasts” and that the evildoers of globalization are conspiring to force Asian countries to open their domestic markets.1 Yet Mahathir has harnessed elements of globalization, specifically international trade and foreign investment, to promote Malaysia’s economic development. Relatively successful at guiding the economy in a strategic manner to comply with its development goals, the Malaysian government has allowed substantial economic liberalization regarding participation in the international market system. In contrast, the domestic market is still tightly managed and highly regulated by the government in order to protect local industries. Privatization efforts were initiated in 1986, but the government maintained ownership of large shares, although not majority shares, in many domestic industries.2 It was predicted at the time that Malaysia’s failure to make substantial progress on key reforms in the corporate and financial sectors would cloud prospects for sustained growth and the return of critical foreign investment.3 The prediction, however, has not proved to hold true in the new century. Malaysia has been successful at attracting and utilizing foreign investment. The government has effectively managed the investments to make them profitable for the investors as well as for Malaysia. 85

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The primary objectives of analyzing Malaysia’s contracts with General Motors are to illustrate the impact of centralized government on investment arrangements and to highlight Malaysia’s strategy to gain indirect benefits such as employment and technology transfer from hosting foreign investment. The Malaysian government has organized investment-promotion institutions and a powerful bureaucracy, which have been able to negotiate mutually beneficial arrangements with foreign investors. The government has institutionalized a code of conduct and has enforced policies to regulate multinational corporations. In the case of General Motors, Malaysia has required specific types of technology transfer and specific amounts of new employment, which have contributed to the formation of a new business class. In exchange, GM has negotiated to get interminable tax holidays from the Malaysian government. Malaysia’s strategy is to give the direct benefits (revenue and repatriation of profits) to foreign investors and to extract the indirect benefits (technology transfer and new employment) to promote domestic economic development. The analysis of Malaysia’s strategy is substantively important because it highlights the indirect benefits that are not captured in the statistical analysis of foreign investment. The case of Malaysia supports the importance of strong institutions for managing foreign investment and illustrates the trade-offs between investor and host benefits.

Background and Structural Change Malaysia is a centralized state with coherent institutions, including an extremely well-organized bureaucracy. The government is a constitutional monarchy with a parliamentary structure. Most of the national policy decisions are made through the executive office and the bureaucracy, which consists of unelected administrators. Although not a democracy, Malaysia does have local elections and representative government in the lower house of parliament. The historical legacy, however, emphasizes central control, executive decisionmaking, elitism, and hereditary succession. Despite the existence of numerous political parties, Malaysia has been under the rule of one party, the United Malays National Organization (UMNO), since independence. The UMNO party designated Mahathir bin Mohamad as prime minister in 1981, and he remained the ruler for over twenty years, most of the time span of this study. The

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government promotes economic conservatism and protectionism within its domestic markets, such as capital controls, limits on importation, and insulation of the auto industry. In contrast, it practices liberal international exportation and participates in the global capitalist market. Malaysia has implemented democratic reforms in the parliament and in local government but maintains a dominant centralized bureaucracy. The government has neglected to strengthen civil society, allow viable opposition, protect minority rights for the Chinese population, and promote general civil liberties. This is in part because the government wants to maintain the power to implement difficult and unpopular economic reforms without having to respond to interest groups and public opposition.

Foreign Investment: Incentives and Constraints Malaysia managed to insulate its economy, as much as possible, from the Asian Financial Crisis. But it managed to aggravate foreign investors in the process. It disallowed repatriation of profits, froze private and corporate bank accounts, and required all international business transactions to be conducted with Malaysian currency during this time. As the crisis passed, Malaysia renewed its commitment to economic liberalization. Other than the currency crackdown, Malaysia has been more open to and lucrative for foreign investors. The government negotiates beneficial tax arrangements for foreign investors that include extensive tax holidays, deductions, and abatements. In addition, it offers foreign companies several tax exemptions for infrastructure projects and modernization of their facilities. The government has coherent rules and regulations as well as clear incentives and constraints for foreign investors. The government actively pursues foreign investors in high tech industries and manufacturing, but also maintains tight control over performance requirements, labor hiring practices, and access to the domestic market, particularly in the automotive sector. Malaysia maintains control over the automotive sector by limiting access to its domestic markets and requiring foreign investments to be joint ventures with Malaysian automakers. It has utilized the joint ventures to increase the employment of Malaysians and ethnic Malay, and to improve the volume of technology transfer. Despite its criticism of the capitalist structure of the global economy, Malaysia has adopted an Export Oriented Industrialization development strategy and relatively free international trade. The govern-

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ment actively pursues foreign direct investment in the manufacturing and technology sectors in order to increase overall production, trade, and technology transfer. Malaysia offers attractive incentives to foreign investors in these industries. However, the Malaysian government retains a high level of discretionary authority over investments.4 This is accomplished in part by subjecting all foreign investment negotiations and contracts to the approval of the Malaysian Industrial Development Authority (MIDA). The authority requires all foreign investment to comply with the economic policies of the government. Each investment has a specific performance requirement written into its individual manufacturing license and contract with the government. According to the contracts awarded by MIDA, the United States was the largest foreign investor in the manufacturing sector, with approved projects valued at US$1,972 million in 2000; Japan was second with $758 million; the Netherlands followed with $572 million; those three together equal 63 percent of the total foreign manufacturing investments. 5 Approval from MIDA depends on the export orientation of production, the percentage of local participation, the amount of technology transfer, and the feasibility of production levels based on current infrastructure. The investment regulations are clear, and MIDA is well organized. Legal codes are specified in the Promotion of Investments Act of 1986, the Industrial Coordination Act of 1975, and the Second Industrial Master Plan 1996–2005. The government has made three points clear in these pieces of legislation regarding foreign investment. First, Malaysia is committed to an EOI development strategy. The country will encourage foreign investment as a means to industrialize, increase exports, and expedite economic growth. Second, foreign investors will increase Malaysia’s integration into the global economy by increasing the volume of production and international trade. Third, the government will protect and promote Malaysian industries. More specifically, each piece of legislation states that foreign-owned firms are required to export most of their production, not sell it domestically, and foreign manufacturers must apply to the Ministry of International Trade and Industry (MITI) for permission to sell up to only 50 percent of its product on the domestic market. This regulation meets the objectives of increasing international trade while protecting local industries and markets. The Promotion of Investments Act of 1986 offers several incentives to foreign investors. It provides partial tax exemption for five years, a reinvestment allowance, and an infrastructure allowance. The govern-

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ment offers a 60-percent tax write-off for capital expenses to expand or modernize an existing facility, and a 100-percent write-off for reconstruction and extension or pavement of roads. The auto industry is the only part of the manufacturing sector that is not included in these benefits. The government protects Malaysia’s auto industry by requiring foreign auto investors to have joint ventures with local industries and excluding foreign equity tax breaks. The act also specifies that all foreign manufacturing investments must pay the nondiscriminatory 28-percent corporate income tax.6 An exception is made if a foreign company qualifies for one of the infrastructure tax exemptions. Another specific code in the legislative acts of 1975, 1986, and 1996 discussed above is that foreign investments must be joint ventures between foreign and Malaysian corporations. The rule is so explicit that it gives guidelines for the percentages of foreign ownership that are allowed in each economic sector. For example, in the manufacturing sector the government limits foreign ownership to 30 percent, requires that products should contain no less than 80-percent materials from local industries, states that all price increases must be approved by the Ministry of Domestic Trade and Consumer Affairs (MDTCA), minimizes foreign employment, and requires proof of a long-term commitment to the local market.7 Only three exceptions have been made to this legal code. Foreign investors that bring high tech industry into the Multimedia Super Corridor (MSC), Asia’s version of Silicon Valley, receive regulatory exemptions as well as tax breaks. The second exception is the relaxation of restrictions on foreign equity in manufacturing projects, allowing foreigners to hold 100-percent equity in any new manufacturing project for which MIDA approved a license between 1998 and 2003. This exemption was part of the National Economic Recovery Plan in response to the 1997 economic crisis, and it was designed to increase the incentives for foreign investors. The plan also enacted currency controls and fixed the value of the ringgit (ringgit Malaysia, or RM) at RM3.8/US$1.0 to insulate the domestic economy from capital flight, offshore trading, and speculative attacks. However, FDI inflows were exempt from the controls in order to preserve the relationships with foreign investors and encourage new investment. The final exemption is for investments that are located in Malaysia’s Free Trade Zones: Port Klang (Westport and Northport), Penang Port, and Johor Port. The FTZs allow export-oriented manufacturing, warehousing, and importation of equipment and raw materials necessary for production, with minimum customs requirements and duty-

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free. The original financial disincentives have been removed, the FTZs offer a new incentive, and thus Malaysia has been able to continue to use foreign investment to increase production, trade, and growth.8 The government does impose one nonfinancial sector constraint: foreign investors must comply with strict labor requirements. Malaysia promotes its high level of labor productivity to attract foreign investors, particularly in the manufacturing sector. It also uses labor as a means to extract indirect benefits from foreign investors. The Malaysian government requires foreign corporations to employ bumiputra (ethnic Malay) in proportion to Malaysia’s ethnic composition, and it strongly encourages joint ventures between foreign firms and bumiputra businesses. In addition, the legal investment code limits the number of foreign and expatriate employees. “A new foreign investment is allotted a certain number of ‘key posts,’ determined by the size of the investment that may be occupied by foreigners.”9 This requirement has contributed to the high level of employment in Malaysia. The employment downturn has recovered from the crisis of 1997, decreasing to 3 percent in 2000. Malaysia no longer seeks labor-intensive industries and reserves its fiscal incentives for high-value-added projects.10 Another constraint on foreign investment is corruption in business and government. Bribery has been recognized by the government as being prevalent among senior state officials and businesspeople.11 In the 1960s, bribes were even tax deductible, but this was eventually eliminated by the Anti-Corruption Agency (ACA). Transparency International ranks Malaysia as less corrupt than South Korea, China, and the Philippines, but more corrupt than Singapore, Hong Kong, and Taiwan. The ACA has taken specific measures to combat corruption; for example, foreign businesspeople are asked to report any individuals who ask for payment in return for government services.12 The most effective strategy, as self-reported by the agency, is to have the ACA investigations announced in the newspapers, to publicly expose and discourage corrupt practices. The government also submits the articles to the international press in order to publicize Malaysia’s commitment to a transparent regulatory system.

The Effects on General Motors Malaysia (Kuala Lumpur) The automotive industry in Malaysia is highly protected by the government. The contract that General Motors has established with the Malaysian Industrial Development Authority is contingent on the long-

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term commitment of GM to provide technology transfer, skills training, capital investment, and limited access to the domestic market. The general policies regarding foreign investment and the specific restrictions in the automotive industry have had four major impacts on General Motors Malaysia. First, General Motors’ investments are required to be joint ventures with Malaysian firms, as specified in the above-mentioned legislative acts of 1975, 1986, and 1996. General Motors first invested in Malaysia in 1971 by acquiring all shares of Capital Motors Assembly Corporation in Tampoi, Malaysia, to form General Motors Malaysia BHD. The law, however, limits foreign ownership in the manufacturing sector to 30 percent, and General Motors sold BHD back to Malaysia (Oriental Holdings BHD of Malaysia) in 1980. General Motors started another joint venture in 1984 with Japan and the Nigerian government. The jointly operated plant produces the Toyota Corolla, which is also sold by GM as the Prizm. One of the stipulations on the joint venture is that neither GM nor Toyota own more than 30 percent of the shares, and the component parts that are imported will be taxed by the Malaysian government at the ports.13 Second, most GM products are required to be exported, not sold domestically, in order to insulate the domestic automotive industry from international competition. The national car program started in the early 1980s was designed to protect and promote the local automobile manufacturers, namely Proton and Perodua.14 Malaysia is one of the largest automotive markets in Asia. During the first quarter of 2000, 75,660 cars were sold in Malaysia, most of which were domestic.15 Foreign companies are severely limited in their access to this market, which means that GM may manufacture and assemble automobiles in Malaysia but must sell the finished products in other markets. General Motors can sell only 100 of each type of vehicle (for a total of 500 vehicles) in the Malaysian market, which is obviously an extremely limited amount. The sale of these automobiles is also considered to be the sale of an imported product, and so the sales are heavily taxed. Tariffs on imports range from 42 to 80 percent on knocked-down cars and 140 to 300 percent on completely built-up cars. General Motors did make an effort to tap into growing auto markets in Southeast Asia and China by announcing it would expand its parts operations in Malaysia and Beijing.16 However, the process was slowed considerably because Malaysia applied for and was granted an extension on its compliance with the ASEAN Free Trade Area (AFTA) agreement. The AFTA requires Southeast Asian countries to cut their import duties on automobiles, which would have expedited the process of increasing GM’s access to Asian markets. However,

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Malaysia had an extension until 2007, in order to protect its domestic automobile industry and to reduce international competition in the region. A third government policy that affects General Motors Malaysia is the strict labor requirement to provide skills training and employ bumiputra. The Malaysian government uses these regulations to ensure that they gain indirect benefits from the foreign investment. In compliance with these requirements, GM facilities include a technical training center to train employees in advanced technologies. This training transfers new skills and technologies into the country as well as expedites the promotion process of Malaysian employees, and thus increases their level of income and standard of living. General Motors is also required to employ a number of bumiputra that is proportional to the actual population. This is important to Malaysian development in two ways. First, the bumiputra are primarily located in rural areas and employed in the agricultural sector; thus, employing them in the industrial sector increases the level of urbanization of the country. Second, increasing the level of employment of the bumiputra advances their overall level of skills training and economic status. These labor requirements for foreign investors address specific development goals of the Malaysian government. A final aspect of the government’s foreign investment policy that specifically affects GM is the tax exemption for high tech industrial projects. The General Motors Corp. unit Hughes Space and Communications Company won a $61.5 million contract to build a telecommunications satellite for Malaysia.17 This project is of great value technologically and financially for both General Motors and Malaysia. It is highly likely that if the Malaysian government did not actively pursue and provide financial incentives for this type of high tech investment, GM would have made this contract in one of the other countries in which it holds substantial investments. This project also demonstrates that the selectivity of the Malaysian government in awarding investment contracts can be advantageous and profitable for both Malaysia and the foreign investor. The Malaysian government does expect foreign firms to practice corporate responsibility, including support for public services. Global Aid supports education programs for GM employees in accordance with the labor requirements of the Malaysian government. The government requires foreign investors to provide free or affordable skills training programs for its employees on a regular basis, at least twice a year. General Motors’ Global Aid skills training programs for Malaysian

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employees have benefited GM employees worldwide by providing easily accessible online programs. Offering more than 2,200 courses to its more than 80,000 executives, management, technical and professional employees around the world,18 the GM program has grown to be so extensive that it is, as of this writing, based at a technical training center called GM University, which provides interactive distance learning (IDL) and e-learning curricula and courses. Although beneficial, this contribution to community development and technical training in Malaysia has not created the same “love affair” with foreign firms as it did in India.

Conclusion The emerging Asian economies have proved to be successful in the application of export-oriented strategies, the development of a comparative advantage in high-end technologies, and the capacity to attract substantial amounts of foreign direct investment. India and Malaysia have marketed High Tech City buildings and technology corridors to draw investors’ attention to the skilled labor force, generous tax incentives, and free enterprise zones. General Motors has used these incentives to become profitable in several Asian locations. The “Chevrolet Indian Revolution,” the Indian love affair with the Chevy, has been highly lucrative for GM because it has gained GM access to the Indian labor market for cost-effective production and access to the Indian consumer market for sales, the second-largest consumer market in the world in terms of population. In Malaysia, General Motors has shown that it can be cost-effective in production and exports alone, despite a tightly controlled auto industry that protects domestic automakers from competition and restricts foreign access to domestic consumer markets. India and Malaysia negotiated indirect benefits with GM. Both countries used the GM investment to increase their integration into the global economy, assert their comparative advantage in modern manufacturing and modern technologies, and demonstrate that foreign firms are profitable in their countries, which is intended to attract additional investors. India and Malaysia have focused on these global-level indirect benefits rather than on direct benefits such as generating government revenue. For this reason, the extent of benefits for India and Malaysia is arguable, especially considering the fickle nature of the global market and the externalities created by foreign corporations whose interests are not the domestic development of their host country.

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Most Asian countries struggled after the Asian Financial Crisis and the “technology bubble burst” prior to this writing. The foreign investors certainly did not race to their aid; many of them actually broke contracts and divested. Even the IMF, which is designed to give shortterm aid to help countries recover from economic crises, was accused of making things worse in Asia by making the recovery more difficult. It is important for emerging markets to consider that there is a fine line between interdependence and dependence. International production, consumption, trade, and investment are positive forces in general, but they can be cloaked as interdependence rather than dependence in a few cases. The interests of foreign investors and host governments often diverge, and an economic crisis will easily expose the facade of convergent interests. Asian governments, including India and Malaysia, may need to develop a strategy to soften the fall if their current growth rates are not sustainable. Even if moderate growth rates are sustainable, they nonetheless may be a letdown after the high growth rates experienced before the financial crisis and those seen in India and China in the early 2000s. Foreign investment has generated much of the economic growth in Asia, and the level of investment inflow may not be sustainable, particularly if the energy crisis in Asia continues. International and Asian expectations are high, which is a positive driving force for expanding economies, but it may be more realistic and more sustainable to pursue incremental economic growth, especially if the growth is largely dependent on foreign investment. Foreign firms are mobile and somewhat fickle, and could leave Asia as quickly as they came, as witnessed during the Asian Financial Crisis. There are costs to moving foreign investments, particularly for direct investments such as factories. But an increase in operational costs or financial risks due to economic insecurity or political instability will motivate foreign firms to relocate, as they did after the Asian market collapse in 1997. The exception to this divestment was Malaysia, which froze foreign capital to prevent firms from relocating. Retaining foreign investment may prove to be a bigger challenge for Asia than attracting it.

Notes 1. Thomas Friedman. 2000. The Lexus and the Olive Tree: Understanding Globalization. New York: Anchor, p. 112. 2. Soo Khoon Goh, 1996, Effect of Foreign Capital Flows on Savings

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and Growth in Malaysia. Boulder: University of Colorado; Peter Searle, 1998, The Riddle of Malaysian Capitalism: Rent-Seekers or Real Capitalists? Honolulu: University of Hawaii Press; Antonio Rappa, 2000, Modernity and Consumption: Theory, Politics, and the Public in Singapore and Malaysia. River Edge, NJ: World Scientific. 3. Virginia Krivis. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 6. 4. Ibid., p. 2. 5. Ibid., p. 12. 6. US Bureau of Economy and Business. 2002, interview, Washington, DC, p. 13. 7. Soo Khoon Goh. 1996. Effect of Foreign Capital Flows on Savings and Growth in Malaysia. Boulder: University of Colorado. 8. Richard Ouma-Onyango. 1997. Information Resources and Technology Transfer Management in Developing Countries. New York: Routledge. 9. Virginia Krivis. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 7. 10. Ibid. 11. Peter Searle. 1998. The Riddle of Malaysian Capitalism: Rent-Seekers or Real Capitalists? Honolulu: University of Hawaii Press. 12. US Bureau of Economy and Business. 2001, interview, Washington, DC, p. 9. 13. “GM Names Communications Managers.” August 16, 2000. Detroit News, p. B0: 3. 14 John Smith and Richard Wagoner. 2002. “General Motors Automotive Divisions and Operations.” Report. New York: General Motors, p. 24. 15. Ibid. 16. “General Motors Corp: Parts Division to Expand in Southeast Asia and China.” May 6, 1994. Wall Street Journal, p. B4: 4. 17. “White House Gets Progress Report on Rights in China.” May 18, 1994. New York Times, p. D4: 1. 18. General Motors Annual Report 2006, 2007. www.GM.com

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7 Adelante: Government Commitments to Reduce Investment Risk in Chile

THE LATIN AMERICAN PUMAS HAVE BEEN overlooked in comparison

to the attention given to the Asian Tigers. Most analyses of foreign investment have focused exclusively on the Asian economic boom and the pursuant financial crisis, and on the recent rise of India and China. Although these cases are volatile and thus quite exciting, with surprising rises and rapid falls, the Latin American Pumas have implemented incremental change and sustainable economic restructuring. There are several remarkable examples of Puma successes, including Mexico’s readjustment after the implementation of NAFTA and Chile’s renewal of credible commitment to economic liberalization. There are also a few cases that have proven to be vulnerable to the volatility of the global market, such as Argentina’s recent currency crisis and economic collapse. Overall, the Latin American Pumas have shown endurance. Chile has been able to attract more foreign direct investment than all Latin American countries except Brazil. The Chilean government has made a rapid transition to economic liberalization and is now marketing unprecedented amounts of industrial and agricultural goods to the United States. General Motors has been growing rapidly in Latin America and has been highly successful in manufacturing operations. In stark contrast to its success in Latin America, GM has suffered economic volatility in North America, losing approximately $38 billion in 2007 but regaining almost $5 billion the following year. It has outsourced thousands of formerly North American jobs to Latin America and Southeast Asia, and has increased exports worldwide. Arguably, it is these international operations that have sustained GM’s status as one of the world’s largest multinational corporations, despite its recent decline in North America. 97

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General Motors has numerous direct investments in Latin America, most of which have been profitable for GM as well as beneficial for the host countries, particularly in comparison with the minimal benefits and negative externalities of GM operations in Africa. General Motors has had to address labor rights violations, such as discrimination against pregnant women, and environmental responsibilities, such as disposal of toxic waste. But NAFTA has expedited the “resolution” of these conflicts in Mexico, and they have not hindered GM’s Latin American operations, which are expanding, as are its sales.

Foreign Investment and Development in Chile Chile has outperformed the rest of Latin America in macroeconomic performance as financially indicated by growth, savings, investment rates, and poverty reduction. A central aspect of this economic success is the government’s innovative approach to FDI. The primary incentives for investors are the functional free trade zones, nondiscretionary treatment of foreign investments, freedom to determine the reinvestment rate, minimal regulations on business and trade, and the absence of performance requirements for production and consumption. Chile does not subsidize foreign investment and does not offer special tax exemptions to foreign investors.1 The combination of minimal regulations of foreign investment and maximum tax revenue for the government has been a successful part of Chile’s economic development strategy. The government of Chile has demonstrated a credible commitment to democratic development and economic growth during the past two decades. It has established coherent political institutions with high levels of democratic accountability, representation, and stability. The legislature has been effective at passing legal codes and policies regarding foreign investment, and the executive branch has backed the legislation with executive decrees. The new democracy boasts unprecedented economic growth from 1991 to 1997, with rapid economic recovery in 2000.2 The only Latin American contemporary that has surpassed this level of growth is Brazil, which has a comparable level of FDI in manufacturing per capita but has had incremental and limited deregulation and economic liberalization. The purpose of analyzing Chile’s arrangements with General Motors is to understand the importance of reducing political risk for foreign investors and to recognize what foreign investors are willing to negotiate in return. Chile is a fascinating case because it does not offer

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tax breaks, contrary to conventional strategies of attracting FDI, and yet it has been able to increase investment inflows more than any other country in Latin America except Brazil. Chile’s strong democratic institutions minimize political discretion and maximize economic freedom. General Motors is risk averse: it wants economic policies to be applied in a predictable, nondiscretionary manner. Chile has the institutional capacity to provide nondiscretionary policymaking, as well as the ability to guarantee freedom of production and consumption. This increases predictability and profitability for GM and all multinational corporations. In return, General Motors is willing to tolerate Chile’s nondiscretionary tax, which is a legal source of direct revenue for the Chilean government. The case of Chile is important for demonstrating that strong institutions with transparent policies can increase the mutual benefits for foreign investors and host countries. The analysis provides insight into the significant role of political institutions and economic policies, and how Chile has adapted to substantial structural change.

Background and Structural Change After sixteen years of military rule under Augusto Pinochet, the freely elected president Patricio Aylwin was installed in 1990 and quickly began implementing political and economic reforms. The government rules through concertacion, or coalition. Coalitions during the past two decades have included the Christian Democratic Party (PDC), Socialist Party (PS), Party for Democracy (PPD), and Radical Social Democratic Party (PRSD). The majority coalition has maintained an emphasis on democratic and socialist policies that are consistent with the party platforms. Coalition parties have cooperated to pass legislation aimed at increasing the level of democratic development and equitable economic redistribution. The legislative efforts to promote democratic development and socialist distribution have been possible in part because Chile had historical experience with democratic institutions and socialist ideology before the rule of Pinochet. Chile has historically had high policy “valance,”3 which means that legislators employ large teams of experts to mix controversial ideologies into coherent policy. This practice has been carried into contemporary politics, and legislators “weigh policy alternatives in terms of ideology . . . on the basis of shared public policy values.” 4 The rise of the middle class over time has also supported democratization and created a “progressive” nationalism.5 These histori-

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cal experiences and contemporary characteristics distinguish Chile from the other cases in this study because they have facilitated the development of a high level of democracy and socialist-ideology-based legislation. During the past decade the increase in political party salience, regular elections, and voter efficacy have improved the level of democracy in Chile. Economic liberalization and democratic reforms have been made through legislation and executive decree, and have not been contradictory or contentious between the legislative and executive branches. This indicates a high level of institutional coherence within the government. Thus, Chile serves as an example of a democratic government with coherent institutions. The case study is conducted for Chile from the Aylwin administration, the first democratically elected president after the Pinochet military regime, to the Bachelet administration.

Foreign Investment: Incentives and Constraints The government of Chile actively works to attract foreign investment and to use that investment to promote domestic development. A Latin American economist for the World Bank explains, “A key feature of the government of Chile’s development strategy is a welcoming attitude towards foreign investors.”6 The success of this strategy is confirmed by the large amount of foreign investment in Chile. The total stock of foreign investment in Chile in 2001 was $44.2 billion, 59.6 percent of Chile’s 2001 GDP. The United States is the largest investor in Chile with a total of $1.76 billion in 2001, followed by Italy with $0.9 billion and Australia with $0.4 billion.7 Other major investors in Chile are Spain, Canada, the United Kingdom, Japan, and Australia. Chile provides these foreign investors with clear and concise rules of operation, and minimal constraints. The most significant statute regarding foreign investment in Chile is the Decree Law 600 (DL600) established by executive decree and ratified by the legislature in 1974. DL600 requires foreign direct investment proposals to be screened and approved by the Foreign Investment Committee (FIC). Investors sign a standardized contract that provides them with specific guaranteed benefits. The contract under DL600 allows investors to • Receive nondiscriminatory treatment • Participate in any form of investment

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• • • •

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Hold assets indefinitely Reinvest earnings immediately; remit capital after one year Acquire foreign currency at the interbank rate of exchange Select their form of taxation, choosing either a variable national tax rate, under which local firms are taxed at a rate of 35 percent on fully distributed earnings, or a guaranteed tax rate set, at this writing, at 42 percent.8

The investment statute underwent two major changes in 2000: (1) elimination of the one-year residency requirement for foreign capital under Chapter 14 of the Central Bank’s Foreign Exchange Regulations, which is generally used for portfolio investment; and (2) elimination of the encaje, or “lock-in,” which requires foreign investors to deposit a percentage of their funds with the Central Bank in a noninterest-bearing account for two years. These amendments eliminated regulations that had previously discouraged foreign investment. The changes reduced residency requirements and profit constraints in order to increase the total amount of foreign investment in Chile after the 1997 financial crisis. An additional piece of legislation, the OPA Law (Ley de OPA), was passed during the economic crisis to provide formal rights and legal protection for minority shareholders. Foreign investment rebounded as a result of DL600 and the OPA Law, and the economy made a remarkable recovery by 2001. To minimize the constraints on foreign investors, the Chilean government does not impose performance requirements on multinational corporations. This is a highly unusual concession to foreign investors. Most countries have performance requirements that regulate a foreign company’s level of production, consumption, imports, exports, and access to domestic markets. Although Chile does require all foreign investment proposals to be approved by the FIC, the government does not mandate performance requirements. The government of Chile provides foreign investors with clear and simple rules, nondiscretionary regulations, and makes substantial efforts to reduce corruption. Overall, the Chilean regulatory system is relatively transparent. The largest problem with transparency is the bribery of government officials. In an effort to combat corruption, the parliament has legislated the Corruption Penal Code and the Administrative Statute of 1986, which give responsibility for fighting corruption to the Contraloria General de la Republica. The executive branch has signed the Organization of American States (OAS) Convention Against Corruption and, in March 2001, signed the Organization for Economic

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Cooperation and Development (OECD) Convention on Combating Bribery. Although both conventions have been ratified by the legislature, “Chilean law has not been modified to implement the [Convention on Combating Bribery] act.”9 Chile has two important labor requirements for foreign investors: basic standards for work safety and technical training for Chilean employees. The government requires foreign corporations to provide at least one technical training class for Chilean managers in order to increase the level of skilled labor and promote technology transfer. These requirements appear to be loosely enforced because there is no domestic documentation of corporations that have failed to comply. International organizations monitor the foreign investment in Chile more closely than does the Chilean government. One of the benefits foreign investors gain from the labor policy in Chile is the autonomy to make labor contracts at the company level. Chile does not have sectoral contracts. This means that foreign corporations can determine the total number of employees, the wages and benefits, and the demographic composition of their employees (there are no quotas for hiring local versus international employees). Overall, corporate-labor relations are peaceful in Chile. There are few labor strikes and only 13 percent of the workforce is unionized.10 The strikes that have occurred in the past decade concerned employee health, education, communications, and privatization of ports. Chile has established several foreign FTZs. The zones provide foreign investors with substantial investment incentives; merchandise can be deposited, transferred, or commercialized without restriction. 11 Another benefit is that foreigners have the same investment opportunities as local Chilean firms in the foreign FTZs. Finally, and most significant, the only subsidies and tax breaks given to foreign investors are allocated to firms that locate in the free trade zones. Recall that Chile does not subsidize foreign investment or give tax exemptions. The only exceptions made are for firms that invest in economically disadvantaged areas in the far northern and southern regions, at the ports of Iquique and Punta Arenas.

The Effects on General Motors Chile Limitada S.A. (Santiago) The investment arrangement between General Motors and Chile has been affected by Chile’s transition to democracy and the substantial

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structural change. The process of democratic development has strengthened the institutional coherence of the legislative and executive branches. These institutions have been able to formulate, pass, and implement specific pieces of legislation to manage foreign investment—such as the OPA Law and DL600 amendments. After the military dictatorship of Augusto Pinochet, the new democratic government of Patricio Aylwin required General Motors to reform and renew its contract with the government’s Foreign Investment Committee. The FIC alleged that GM chief executives were not supportive of the new democratic regime, and suggested that GM replace its top leadership as part of its new contract. As reported within the year, “The General Motors Corp has announced several personnel moves, including Lynn C. Myers as general director and Alan W. Kennedy, who becomes managing director of GM Chile S.A.”12 Another important aspect of the contract renewal was that it obligated GM to improve technical training for employees, the goal being to develop a more skilled labor force and increase the level of technology transfer. General Motors agreed to hold two training sessions per year, one to promote the professional development of managers and one to advance the technical skills of midlevel employees. The FIC successfully negotiated a GM personnel adjustment and an expansion in managerial and technology training for Chilean employees. Liberal economic reforms provided new benefits to General Motors in Chile during the early 1990s. The Chilean parliament passed a series of legislation from 1990 to 1995 that amended DL600 in order to decrease regulations on production and restrictions on access to domestic markets. The FIC implemented these reforms by allowing General Motors to increase the total amount of capital they produced, imported, bought, and sold in the Chilean market. These changes fostered GM’s expansion of the assembly plant to include a warehouse for imports and exports, and augmentation of administrative functions. The gradual reduction of restrictions and requirements, most of which were completely eliminated in 2000, permitted a diversification of production as well as an increase in exports to other Latin American markets.

Notes 1. Carlos Capurro. 2002. “Chile: Country Commercial Guide.” Washington, DC: United States and Foreign Commercial Service, p. 3. 2. Perry Guillermo. 1999. Chile: Recent Policy Lessons and Emerging Challenges. Washington, DC: World Bank.

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3. R. Stokes. 1968. The Study of Political Generations. Essex, UK: Longmans/University of Essex. 4. John Londregan. 2000. Legislative Institutions and Ideology in Chile. Cambridge: Cambridge University Press, p. 13. 5. Patrick Barr-Melej. 2001. Reforming Chile: Cultural Politics, Nationalism, and the Rise of the Middle Class. Chapel Hill: University of North Carolina Press. 6. Carlos Capurro. 2002. “Chile: Country Commercial Guide.” Washington, DC: United States and Foreign Commercial Service, p. 1. 7. Ibid., p. 6. 8. Ibid., pp. 3–6. 9. Ibid., p. 12. 10. James Rigassio. 2002. “Market Research Report.” Washington, DC: United States and Foreign Commercial Service, p. 14. 11. Ibid. 12. “General Motors.” May 28, 1990. Detroit News, p. D2: 5.

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8 After NAFTA: Attracting Multinationals with Free Enterprise Zones in Mexico

ECONOMIC DEVELOPMENT AND FOREIGN INVESTMENT IN Mexico

are so pervasively influenced by the North American Free Trade Agreement that it is inaccurate to discuss it as anything other than interdependence. Mexico sends 90 percent of its exports to the United States.1 It also receives approximately 75 percent of its imports from the United States.2 Internationally competitive multinational corporations have invested heavily in Mexico’s automotive and manufacturing sectors, including Ford, Volkswagen, Motorola, Monsanto, Coca-Cola, Pepsi, General Electric, General Motors, and many others. It is well known that General Motors has outsourced tens of thousands of jobs from the United States to Mexico. It is less well known, but equally indicative, that Mexico is starting to see the movement of foreign firms out of Mexico and into China. Mexico has been working to offer attractive, lucrative, and sustainable investment arrangements to gain and retain foreign firms. The purpose of analyzing Mexico’s arrangements with General Motors is to highlight the effects of political institutions and economic dependence on the relationship between foreign investment and domestic development. The North American Free Trade Agreement has determined most of the interregional incentives and constraints for foreign investment, and claims to promote the best development strategy. The Mexican government has facilitated the implementation of NAFTA by providing programs for export-oriented manufacturing and for priority development zones. Benefiting from the incentive programs and the ease of outsourcing under NAFTA, General Motors has grown to be the largest private employer in Mexico, which gives GM a substantial amount of political and economic leverage. General Motors has been 105

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able to negotiate numerous long-term tax breaks and repatriation of profits. This decreases direct revenue and reinvestment capital for the Mexican government, which normally does not give extensive tax breaks. Arguably, Mexico has gained benefits at the micro- and macrolevel from hosting GM. At the microlevel, political institutions have been able to provide coherent labor policies, which have improved workers’ rights and antidiscrimination practices at GM’s factories, especially after GM’s labor abuses and gender discrimination were exposed in the international press in the late 1990s. Mexico has also benefited at the macrolevel, although the indicators are more abstract. General Motors has helped expedite Mexico’s economic liberalization by opening international trade and foreign investment, and facilitating the transition from the import substitution industrialization model to the exportoriented industrialization model. General Motors’ Global Operations won the “Good Partner Award” from the United States and Mexico for these macrolevel contributions to economic liberalization and foreign investment.

Background and Structural Change Mexico has had four consecutive government administrations committed to economic growth and integration into the global market, now that Mexico has abandoned the ISI model in favor of EOI. One recurrent problem, however, is that each government administration over the last fifty years has unintentionally triggered a financial crisis at the end of its administration. The phenomenon is so distinct that it has generated its own terminology and is referred to as the sexenio. The government has not been able to avoid the sexenio, which has negative effects on growth and risk-averse foreign investors. Former president Ernesto Zedillo tried to prevent it by aggressively securing foreign investment, providing investment insurance, promoting economic liberalization, restructuring the debt, and building the financial reserves to facilitate a smooth transition after the presidential election of 2000. In the end, however, the sexenio has become a self-fulfilling prophecy, continuing to scar elections and political transitions. Mexico has been holding elections since its revolution, but it was a single-party state until 2000. Arguably, the single-party history of Mexico was relatively stable because it repressed the opposition during the 1960s and 1970s. The Partido Revolucionario Institucional (PRI) ruled for over seventy years in Mexico until the Partido Accion

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Nacional (PAN) candidate and former Coca-Cola Mexico CEO, Vicente Fox, emerged victorious in the presidential election of 2000. The election was not a radical transition of power from conservative to liberal ideology. Fox and the PAN fit squarely on the conservative side of the political and economic spectrum along with the PRI, but the election was important because it established the viability of alternative, competitive political parties in Mexico. Thus, the state transitioned from a procedural democracy to a more substantive democracy. In 2006 the elections resulted in the victory of another PAN candidate, Felipe Calderon. The 2006 transition, however, was not as smooth. There were weeks of mass political protests, accusations that the election results were fraudulent, and demands for a vote recount. A “parallel government” was created by Andrés Manuel López Obrero, who claimed to be the rightful winner of the presidential election. In contrast to the 2006 election controversy, the new multiparty competition and increasing public demands for democratic representation have been slowly increasing the government’s accountability to the needs and interests of the general population. But Mexico is plagued by persistent problems of poverty, corruption, dependence, inadequate infrastructure, crime, poor safety and security in urban areas, parastatal monopolies, and social unrest provoked by large wealth disparity. Another challenge for foreign investors is that Mexico’s business environment is dominated by small retailers and family-owned businesses. “Only 2.2 percent of all industrial firms have more than 250 employees; more than 90 percent employ only 10–15 workers.”3 It is not necessarily negative for Mexico’s level of employment to have high numbers of local retailers and family businesses, but it indicates that the investment environment and business infrastructure were initially designed around the needs of small businesses. Despite this obstacle to large-scale multinational operations, the Mexican government continues to expedite liberalization and deregulation, comply with NAFTA, improve business practices, and pursue foreign investment. Mexico has been able to attract substantial foreign investment and achieve economic growth by promoting maquiladora programs for assembly plants and export-linked manufacturing, which are now the principal growth sectors.

Foreign Investment: Incentives and Constraints The Mexican government has established coherent institutions, rules, regulations, rights, and responsibilities for foreign investors. The investment policies are articulated in the foreign investment laws and consti-

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tutional amendments of 1993, 1995, and 1997. It is not coincidental that the foreign investment laws were developed during the implementation of NAFTA and were designed to be extremely liberal. Mexico has been transformed “from one of the most protectionist economies, with a large role for government, to one of the most liberalized.”4 The laws cited above, in accordance with NAFTA, have made Mexico more open to foreign investment and have given multinational corporations nondiscretionary treatment comparable to that accorded to domestic firms. In addition, the laws offer incentives, such as automatic approval of foreign investments, privatization of large parastatal enterprises such as communication and transportation, repatriation of profits, free enterprise zones, deregulation, and nonimposition of performance requirements, with the exception mentioned below. In contrast, there are sociostructural constraints on foreign investment in Mexico, such as poor infrastructure, business and government collusion, minimal tax breaks, and inefficiencies in production. There are also a few notable contradictions in the balance between incentives and constraints. For example, Mexico has been privatizing parastatals in parts of the energy sector but not in oil or other hydrocarbons. Further, Mexico claims it does not have performance requirements for foreign firms, but it does impose performance requirements for maquiladora companies, which are primarily foreign firms. The most liberal incentive for multinational corporations is the automatic approval policy for foreign investments. The foreign investment laws eliminate the need for government approval for about 95 percent of all foreign investments.5 The remaining 5 percent must apply for approval because they propose investments over US$25 million. In order to expedite the approval process and act on investment applications within forty-five days, the government has developed a high level of institutional capacity in the National Foreign Investment Commission. The Investment Commission uses criteria such as technology transfer, employment, and skills training to approve applications, but has rejected investment applications that appear to threaten national security or national industries such as oil and PEMEX (the parastatal petroleum company), which Mexico has no intention of privatizing. A clear inconsistency is evident in Mexico’s privatization policy. Although the policy is liberal overall, the process of privatization is limited to specific state-owned enterprises in a few economic sectors: telecommunications and transportation. Mexico sold the long-distance telephone branch of Telmex, the state-owned telecommunications monopoly and privatized satellite technologies and services. It also pri-

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vatized transportation parastatals for airports and railroads, approximately three-fourths of which are now privately owned. However, Mexico retained ownership of the domestic telecommunications industries including domestic telephone service, radio, and television, as well as all domestic land transportation except railroads and international transportation between Mexico and the United States. The uneasy balance of incentives and constraints in the energy sector also exposes two contrasting dynamics. First, the Mexican government facilitates privatization in a specific part of the energy sector. Foreign firms can invest in the storage and transportation of natural gas, but they cannot invest in the extractive industries—that is, foreign investors can store natural gas and transport it, but they cannot buy extraction or drilling rights. They can, however, invest in nonhydrocarbon methods of generating power, such as wind or solar power, but the Mexican government maintains ownership of all power transmission grids. Second, there is no privatization of oil. The Mexican government still owns PEMEX and prevents foreign investors from drilling, storing, transporting, refining, distributing, and selling oil/petroleum and other hydrocarbons. Major foreign investors, including the United States, with strong oil interests are lobbying the World Trade Organization and NAFTA to obligate Mexico to privatize its energy sector, including oil. But Mexico argues that its oil resources are a matter of national, energy, and economic security, and thus it will not privatize energy or oil. The Mexican government has widespread constituent support for its energy policy and national control over oil. Citizens have a constitutional right to have the government manage and distribute their nation’s oil wealth; it would require a constitutional amendment to permit foreign ownership of Mexico’s oil. In a recent proposal, an amendment to open energy and oil to private investment met with so much resistance that it was not even debated in Congress.6 In the manufacturing sector, Mexico has established special incentives for foreign firms to locate in free enterprise zones, called priority development zones (PDZs) in Mexico, and for companies to develop “priority” industries such as machinery and computer technology. The PDZs are intended to expand exports in line with Mexico’s relatively new EOI strategy. The most extensive and notorious PDZs are the maquiladoras that have sprung up along the US-Mexico border. The two primary incentives for foreign firms to build maquiladoras are these: (1) there are no import taxes levied on machines, equipment, and raw materials that are imported as inputs for production in the PDZs; NAFTA

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levies heavy taxes on imports to the non-PDZs from non-NAFTA countries; and (2) the government of Mexico finances the construction of infrastructure projects for transportation, electricity, and sanitation. Foreign investors have reported that the inadequate infrastructure in Mexico is a deterrent to investment, especially for direct investment in assembly plants and manufacturing facilities. The PDZs are working to correct this inadequate infrastructure and attract investors from the United States to the border regions to expand maquiladoras. The infrastructure improvements, import tax exemptions, and the maquiladora programs in the priority development zones are designed to increase exports from Mexico to the United States. For this reason, foreign firms must comply with performance requirements. “To qualify for the maquiladora program, companies must export more than 30 percent of their production on an annual basis.”7 This export requirement is the only remaining performance requirement for foreign firms in Mexico. NAFTA has eliminated all other formal performance requirements. The requirements are not necessary for the large volume of imports and exports between Mexico and the United States because Mexico embraces US standards, business practices, and consumer styles.8 The import tax exemptions in the PDZs are one of the few tax breaks available to foreign investors in Mexico. The Mexican government offers minimal tax breaks and reductions in real estate taxes to foreign firms that invest in publishing or agriculture. Similar to Chile, which offers no tax breaks to foreign firms and yet attracts a high level of foreign investment, Mexico gains substantial revenue from taxing multinational corporations. The standard international investment theory is that foreign investors will locate in whatever country offers the lowest tax rates. This theory is again proven to be a fallacy because Mexico and Chile have low or no tax breaks and still attract the highest levels of foreign investment in Latin America. The alternative incentives, such as the maquiladora program, free enterprise zones, NAFTA (in Mexico) and nondiscretionary taxation (in Chile) are enough to foster lucrative investments for foreign firms and revenue-generating arrangements for host countries. One of the major obstacles for foreign investors in Mexico is the level of corruption, particularly in the government bureaucracy and regulatory system. Foreign firms identify bureaucracy, government decisionmaking, discretionary tax application, and lack of transparency as the principal negative factors inhibiting investment in Mexico. 9 The government recognizes that corruption in the regulatory system imposes discretionary constraints on foreign investment and is working to imple-

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ment standard regulations, eliminate unnecessary regulations, and stabilize the investment environment. One of the unpredicted symptoms of the lack of transparency is that government officials and international business executives are often kidnapped because “outsiders” want to assert influence in the decisionmaking process. Acknowledging that the level of kidnappings is alarming, the Mexican government is trying to establish institutional channels for interest groups to assert influence and resolve conflict. Coherent institutional channels are indicators of democratic consolidation and reduce political risk for foreign investors. The lack of transparency in the regulatory system also affects labor relations among foreign firms, domestic labor, and wider international markets. Since the early 1990s the labor rights abuses in the maquiladoras in the north and the land grabs for oil in the south have received international media attention. The international labor rights community has also drawn attention to the lack of transparency in government regulations on business practices in the maquiladoras, export-processing factories, and free enterprise zones. The government failed to hold US businesses accountable for illegal behavior such as sex discrimination, sex abuse, and illegal mistreatment of pregnant workers. Human Rights Watch specifically cited General Motors, Sunbeam Oster, and Zenith as complicit in corrupt government regulations and business practices.10 In addition to international nongovernmental organizations (NGOs), domestic groups such as the Zapatista National Liberation Army, the Popular Revolutionary Army, and the Revolutionary Army of the People’s Insurgency have mobilized around the progressive workers rights and human rights awarded in the Mexican Constitution and have organized peaceful mass demonstrations as well as small violent attacks, including criminal activity such as kidnappings, to demand influence in opaque decisionmaking and business arrangements. Their allegations of government and business collusion are not unfounded, specifically regarding the attraction and retention of foreign investors in the maquiladoras and PDZs on the US-Mexico border.

The Effects on General Motors de Mexico General Motors is the largest private employer in Mexico, with manufacturing plants in Toluca, Mexico State, Silao, Guanajuato, Ramos Arizpe, Coahuila, and Mexico City. The maquiladora programs, NAFTA, and the priority development zones have had substantial effects on GM de Mexico. NAFTA has increased outsourcing, and Mexico has

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absorbed many of the outsourced jobs, including tens of thousands of General Motors jobs that have moved from the United States to Mexico. Both NAFTA and Mexico’s performance requirements mandate that GM de Mexico focus on manufacturing and exports. The Mexican government requires that foreign manufacturing companies in the maquiladora programs and the PDZs export 30 percent of their goods, which is not a problem for GM de Mexico. The company manufactures and exports Chevrolet, Pontiac, Cadillac, Fiat, and Saab—specifically the models Cavalier, Sunfire, Silverado, and Suburban—and exports to the United States, Canada, Argentina, Chile, Ecuador, Peru, Central America, and the Caribbean. In addition to its exports, GM de Mexico sells more automobiles in Mexico than any other automotive company. The maquiladora programs and priority development zones have been lucrative for GM. They have also created jobs in economically desperate areas. However, maquiladora programs have suffered several public relations problems and a few legal disputes among the Mexican government, NAFTA, the United States, foreign investors, and General Motors. The Mexican government’s environmental regulations for industrial pollution and toxic emissions are higher than NAFTA’s environmental regulations but lower than US environmental regulations, which appeals to foreign investors calculating to save costs on waste disposal and industrial emissions. But the Mexican government is slowly working toward more environmentally responsible and sustainable business practices. Mexico no longer wants to absorb the costs of environmental externalities caused by foreign firms under NAFTA’s lax environmental rules. Thus, the Mexican government has actively negotiated with foreign firms to improve their environmental practices, with mixed results. Foreign corporations’ level of credible commitment to environmental conservation has varied. The most coherent institutional arrangement to improve the environmental practices of industries in Mexico, which affects General Motors, is the collaborative arrangement involving the Mexican Secretariat of Environment and Natural Resources (SEMARNAT), the World Resources Institute, and the World Business Council for Sustainable Development. Referred to as the Mexico GHG Program (Mexico Green House Gas Program), the arrangement provides for monitoring of the industrial processes, energy use, industrial pollution, and greenhouse gas emissions of General Motors and twenty-six other major industrial producers in Mexico. Although there is no enforcement mechanism, the Mexican government has been able to provide information to industries regarding how participation in the program is

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good for business, i.e., good for the bottom line. The GHG Program offers companies free technical tools, training, consultation, and equipment to improve their energy efficiency. General Motors has saved approximately a million dollars a year by participating in the GHG Program, reducing and recycling its energy sources for industrial production. Executives of General Motors have recited the remarks of World Resources Institute president Jonathan Lash, by saying “This is important leadership by the Mexican government to produce both environmental and business benefits.”11 General Motors announced that it would comply with NAFTA’s environmental standards, which, as previously mentioned, are minimal in comparison with the Mexican government’s standards. General Motors had been implicated in illegal and extensive dumping of toxic waste near its maquiladora sites. As the international media coverage of GM’s dumping increased, so did public protest. Public pressure became so great that GM agreed to restructure its toxic waste disposal and now recycles 94.5 percent of its hazardous and nonhazardous waste into alternative fuels. Benefiting the environment surrounding the GM manufacturing plants, the recycling has been good for GM’s bottom line as well, saving GM about $990,000 a year.12 The Mexican government also imposes basic labor requirements to provide a nonhazardous workplace, to prevent discrimination, and to encourage compliance with the international labor rights articulated by the International Labour Organization. The labor rights are so elemental that they would not warrant special mention except for the fact that a few of the basic rights have been violated by GM and other foreign corporations. There have been numerous legal disputes over toxic pollution at work sites, as discussed above, and about women’s rights in the maquiladoras. Several dozen national and international legal disputes have exposed sex discrimination and sex abuse of women employees in maquiladoras run by foreign firms, including GM. Evidence has been presented in these lawsuits that foreign firms and maquiladora programs have discriminatory hiring practices and routine firing of women who were suspected of being pregnant. General Motors had been requiring women to show their sanitary napkins to their supervisors to verify that they were not pregnant. If they did not or could not produce the napkins, they were assumed to be pregnant and were fired.13 The practice had three dynamics: (1) it was degrading and discriminatory against women in general, (2) it was discriminating against pregnant women in particular, and (3) it was an attempt to discourage women from seeking employment in the first place, at least at the maquiladoras. General

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Motors was implicated in the discrimination and had to publicly declare that it had stopped discriminating against women and no longer tested or inquired about women’s pregnancy status. There has been no verified evidence or formal legal dispute since GM declared in 1997 that it would stop the discrimination. The intervention of the Mexican government in cooperation with the International Labour Organization has increased compliance through ongoing monitoring. In addition, the Mexican government has increased its capacity to formulate and implement new policies on labor requirements, workplace safety, and business practices of foreign firms operating in the free trade maquiladora zones. The government’s capacity to increase democratic accountability and policy transparency, particularly regarding multinational business practices, has helped harness the new investments to promote Mexico’s export-oriented development strategy. The primary goals have been to expand the private sector, gain revenue from hosting foreign firms, and adapt to the liberal economic reforms determined by NAFTA. Mexico has succeeded in forwarding the first and last goals, but has not been as successful in gaining government revenue from hosting foreign firms. This is because most of the incentives for foreign investment are allocated to the maquiladora regions, in which the power of the domestic government is limited by NAFTA, and the multinational corporations are exempt from contributing tax revenue. To legitimize and advertise the primary goals, the United States and Mexican governments started the Partnership for Prosperity–Good Partner Award in 2004 to recognize the contributions of the private sector to the development of Mexico. The first winner of the Good Partner Award was General Motors de Mexico, in recognition of its augmentation of the private sector, and for expediting the process of industrialization, supporting the EOI strategy, producing manufactured goods, and increasing exports from the maquiladora zones to the United States.

Conclusion The World Bank study, “Globalization, Growth and Poverty: Building an Inclusive World Economy,” suggests the most important development reform is to improve the investment environment through good economic governance: measures to combat corruption, better functioning bureaucracies, and better regulation.14 In combination with the ability to pass effective legislation, democratic accountability and representation of a plurality of interests provide an optimal combination for

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maximizing the ability of developing countries to attract and utilize foreign investment. Mexico has been actively improving the institutional and economic environment for its domestic population as well as foreign investors. Elections are more competitive, administrations are more accountable, and Mexico has used priority development zones and NAFTA to launch into the export-oriented global economy. However, the case of Mexico’s institutional and economic success, relevant to foreign investment, should not be overstated. The 2006 elections were vigorously disputed, and an alternative, parallel government was initiated in protest of election fraud. Mexico also remains highly dependent on the United States, with the overwhelming majority of its exports going to the United States and the majority of its imports coming from the United States. This dependence, or severely asymmetrical interdependence, gives a disproportionately high amount of leverage to US multinational corporations. Thus, most foreign firms agree to locate only in PDZs that have minimal production and consumption requirements, and that confer preferential treatment, in comparison with domestic firms. For making such accommodations, Mexico gains employment, technology transfer, and industrial development, and is able to extract tax revenue from lucrative multinational operations. There is an important similarity here with Chile. Mexico and Chile have negotiated investment arrangements that both increase their direct tax revenue from hosting foreign investment and maximize alternative incentives and benefits for foreign investors. Chile is most remarkable in this regard because it does not offer any tax breaks for foreign firms, but has one of the highest levels of foreign investment in Latin America, falsifying common assumptions about trade-offs. Chile and Mexico are able to extract direct tax revenue benefits from foreign investment, while most developing countries are not, because they have the capacity to offer institutional incentives such as stability and transparency, lowering the risk for foreign investors. It is this risk reduction that is most valuable to foreign investors in developing countries. Mexico still has obstacles such as crime and social instability, underdeveloped infrastructure, turmoil around the electoral cycle, and the sexenio economic crisis that occurs during each presidential transition. Yet progress regarding foreign investment and domestic development is evident.

Notes 1. United States and Foreign Commercial Service. 2000. “Mexico: Country Commercial Guide,” Mexico City, p. 2.

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2. Ibid. 3. US Embassy, Mexico City, Bureau of Economy and Business. Report and interview. 2006, p. 5. 4. United States and Foreign Commercial Service. 2000. Country Commercial Guide: Mexico, Mexico City, p. 10. 5. Ibid., p. 76. 6. US Embassy, Mexico City, Bureau of Economy and Business. Annual report and interview, 2006, p. 7. 7. US Embassy, Mexico City, Bureau of Economy and Business. June 1, 1998. Federal Official Gazette, p. 81. 8. US Embassy, Mexico City, Bureau of Economy and Business. Federal Decree, November 13, 1998, p. 88. 9. US Embassy, Mexico City, Bureau of Economy and Business. Annual report and interview, p. 85. 10. Human Rights Watch. 2007. Corporations and Human Rights. New York: Human Rights Watch, p. 5. 11. Paul Mackie (ed.). 2006. Sustainable Transport Project. Washington, DC: World Resources Institute. 12. Ibid. 13. Human Rights Watch. 2007. Corporations and Human Rights. New York: Human Rights Watch. 14. World Bank. 2002. Global Development Finance Report. Washington, DC: World Bank Group, p. 2.

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9 Looking Forward: The Trajectory of Foreign Investment and Domestic Development

FOREIGN INVESTMENT CAN EXPEDITE THE PROCESS of development

in poor countries by providing industry, capital, infrastructure, employment, revenue, and technology. Yet there is wide variation in the success and failure of developing countries to maximize domestic benefits and minimize negative externalities from hosting foreign investment. The essential elements of success are political, not economic. The results of this research do not support economic determinism; economic variables alone cannot explain the complicated relationship between foreign investment and domestic development. There are obvious failures within developing countries, such as the failure to attract sufficient foreign investment or the inability to use investment to generate growth. Institutions can serve as corrective mechanisms to these market failures. Political institutions can offer incentives and constraints to foreign investors, mediate conflicts of interest, and decrease the disparity of power between foreign investors and domestic host governments in order to create a more equitable balance of benefits. In other words, institutions can moderate the politics of profit. Globalization of production and consumption has sparked a dramatic expansion of foreign investment. The substantial increase in foreign investment affords developing countries the opportunity to improve their access to the international economy and to establish new investment patterns. There are discernible differences in regime types and institutional arrangements that result in distinct investment patterns. First, foreign investment can be used most effectively to promote economic development in poor countries that have strong political institutions. Second, the use of foreign investment to foster domestic economic growth is contingent on the interaction effects of foreign investment 117

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with democratic institutions and government effectiveness, measured as the capacity to implement policy and provide public goods. Third, democratic states are most successful at attracting foreign investment, extracting government revenue from the investment, parlaying foreign investment into domestic growth, and translating revenue into government expenditure on domestic development projects such as infrastructure and provision of public services. Democratic states can extract direct and indirect benefits from foreign investment, but are most successful at extracting direct benefits. Finally, nondemocratic states are more successful at gaining indirect benefits than direct benefits from foreign investment, such as skills training and technology transfer. Developing countries can extract greater benefits from foreign investment, without deterring the investment, by passing legislation that maximizes the economic freedom of production and consumption, and standardizes the domestic requirements and benefits. Cross-national analysis demonstrates the significance of the interaction effects of foreign investment with government effectiveness, including the capacity to negotiate investments and maintain stability and transparency. The case studies suggest specific types of legislation to maximize the benefits for both the foreign investor and the domestic host country. Results of these studies point to specific types of legislation found to be successful: minimization of regulations on production and consumption, elimination of performance requirements, standardization of a nondiscretionary tax rate, and negotiation or requirement of a specific amount of new employment and technology transfer. Democratic states that practice good economic governance are most successful at passing this type of legislation to encourage foreign investment by providing standardized tax rates and freedom of production and consumption, as well as allocating government expenditures to domestic development programs such as infrastructure and public goods and services. Nondemocratic regimes with effective institutions are successful at negotiating or mandating that foreign investors increase the level of employment, skills training, and technology transfer, as in the case of Malaysia. In contrast, regimes with incoherent institutions do not demonstrate the capacity for good economic governance and thus cannot utilize foreign investment effectively. They often conform to an exploitative relationship with foreign investors rather than one that could promote domestic development. The concluding discussion explains each of these results with their theoretical justifications and empirical evidence, as well as their policy implications. Recognizing that the capacity to utilize foreign investment to pro-

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mote domestic growth in poor countries is contingent on the presence of a strong institutional framework provides some insight into why the expansion of foreign investment over several decades, and the movement of billions of dollars of investment into the developing world, have not substantially altered poverty and scarcity in many poor countries. Foreign investment is premature in countries that lack a strong institutional framework because they do not have the governmental capacity to negotiate beneficial investment arrangements. Democratic regimes promise accountability and representation of a plurality of interests regarding the rights and responsibilities, as well as the costs and benefits, of hosting foreign investment. This promotes the good economic governance recommended by the World Bank for improving the investment environment and making progress in development reform. In addition, coherent institutions provide the government with the capacity to pass effective legislation pertaining to foreign investment, such as guidelines for contractual agreements. Capable institutions also allow governments to negotiate who will absorb the costs of infrastructure development, provision of public services and utilities, taxation, labor requirements, technology transfer, and externalities. Several nondemocratic regimes with effective government institutions are also successful in these endeavors. However, there has been some distortion in representing their success because, unlike the successful Asian Tigers, the majority of nondemocracies are not successful at attracting foreign investment or translating what investment they do attract into domestic growth. Because democratic regimes with effective institutions and good economic governance provide an optimal framework for maximizing the ability of developing countries to attract and utilize foreign investment for domestic growth, developing countries must first focus on institutional development in order to build the capacity to establish beneficial foreign investment patterns. Empirical evidence to support these conclusions is presented in both the cross-national analysis and comparative case studies. The crossnational analysis demonstrates that the interaction effects of foreign investment with democratic and effective institutions are statistically significant. In other words, the amount of benefits from foreign investment is not simply a function of the total amount of foreign investment. A host country may have many foreign investors but may have more costs or externalities than benefits. The benefits must be negotiated. Inclusion of the interaction effects increases the explanatory value of the model, which supports the synergistic approach posited in this research

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to combine the effects of political institutions and political economy variables. The synergistic model shows that democratic and effective institutions are the most successful at generating revenue from foreign investment and translating the revenue into domestic development. These results are reinforced by the comparative case studies of Chile, Mexico, India, Malaysia, Kenya, and Nigeria, which demonstrate the trend that democratic states with strong institutions are the most capable of passing legislation to manage investments and to establish legal codes that maximize their domestic development benefits. Democratic regimes with coherent policymaking institutions tend to establish legislation that does not place heavy restrictions on production, consumption, imports, and exports. In exchange for this freedom of production and consumption, foreign investors will tolerate a higher tax rate, if the tax rate is nondiscretionary. Democratic governments also translate this tax revenue from foreign investment into expenditure on domestic development such as infrastructure as well as public goods and services, plausibly because of democratic accountability and public demands on government revenues and resources. The evidence suggests that although nondemocracies also allocate funds to infrastructure development and public goods and services, the focus regarding foreign investment is not on raising government revenue through taxation to support these domestic development programs. Rather, the focus is on increasing employment and skills training. Nondemocracies with effective institutions tend to have more government regulations on the production and consumption of foreign investments, and tighter restrictions on access to domestic markets. They also mandate specific requirements regarding employment (such as the requirement to employ a certain amount of ethnic Malay in Malaysia), contracts for technology transfer, and managerial and technological training. There is a qualitative difference in the types of domestic benefits governments can negotiate from foreign investment. The country cases in this study suggest that democracies are more successful at gaining direct benefits (such as government revenue) and nondemocracies are more successful at gaining indirect benefits (such as skills training and technology transfer), on the condition that they have competent institutions to legislate and enforce policies regarding foreign investment. One of the most successful cases of using foreign investment to promote domestic development is Chile, during its transition to democracy. Chile does not offer tax breaks or financial subsidies to foreign investors. Yet it has managed to surpass most developing countries in its

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capacity to attract foreign investment, increase the rate of economic growth, and expedite the process of development. The government is able to attract and retain foreign investment through institutional incentives, not financial. One of Chile’s most important institutional reforms was its strengthening of accountability and transparency in the interest of minimizing the discretionary application of policies, such as the discretionary taxation of foreign investments. International investors are willing to pay nondiscretionary taxes to operate lucrative businesses in Chile. They are not willing to tolerate discretionary taxes that could change with the political leadership or could be lower for their competitors. Political discretion is regarded as increasing economic risk. Chile has minimized domestic political discretion by standardizing and institutionalizing its investment rules, and thus has reduced the risk for foreign investors. Consequently, the Chilean government does not have to offer investors expensive subsidies or tax abatements, which decrease government revenue from hosting foreign investment. Chile provides an investment environment with a minimum amount of discretionary policy and a maximum level of economic freedom. This allows the investment to be as profitable as possible for the investor, but not at the expense of sacrificing domestic government revenue. The coherent institutional framework in Chile also allows the government to successfully pass and enforce legislation to eliminate performance requirements, minimize regulations on production and consumption, and limit restrictions on domestic business and international trade. In addition, the democratic organization of the government promotes the allocation of revenue in a manner that is consistent with the socialdemocratic leanings of the dominant political party, the current composition of the parliament, and the demands of the public majority. The clarity of investment codes and the capacity to promote development distinguish Chile from other foreign investment destinations. There are two possible challenges to the cross-national results: Kenya, a weak democracy that has not effectively attracted or utilized large amounts of foreign investment; and Malaysia, a nondemocracy that has been highly successful in managing foreign investment to promote domestic growth. The qualitative findings, however, do support the central theory that strong political institutions can increase the capacity of host countries to negotiate mutually profitable investment arrangements with powerful multinational investors. Kenya’s failure to attract and utilize substantial amounts of foreign investment is due to its fledging democracy and ineffective institutions, which deter investors and make it difficult to negotiate beneficial arrangements. The most indica-

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tive difference between the democratic regimes in Kenya and Chile is that Kenya has not been able to convincingly increase democratic accountability and transparency or to establish nondiscretionary political and economic policies. Thus, Kenya has failed to reverse the trend of divestment. While Kenya suffers widespread divestment, Chile is increasing foreign investment more rapidly than any other Latin American country except Brazil. In contrast, Malaysia has a highly organized institutional hierarchy and an effective powerful bureaucracy, which have made it possible to attract a substantial amount of foreign investment and maximize indirect benefits such as employment and skills training. Regarding effective management of foreign investment, both Malaysia and Chile have developed well-organized, effective institutional arrangements to negotiate and govern foreign investments, and thus have been able to maximize their domestic development benefits. One important distinction, however, is in the type of benefits. Democratic Chile is more successful at gaining direct benefits such as government revenue and infrastructure development than is nondemocratic Malaysia, which gains primarily indirect benefits such as employment of ethnic Malay and skills-training programs. This qualitative finding is important because the indirect benefits were not emphasized in the statistical cross-national analysis. The acquisition of indirect benefits would have been overlooked without the comparative case analyses. The finding also qualifies the conditions under which effective institutions can compensate for a low level of democracy in regard to attracting and utilizing foreign investment. The studies of Kenya, Chile, and Malaysia provide additional support for the central theory by demonstrating that the indirect benefits of foreign investment are also contingent on the interaction effects of foreign investment with coherent institutions that can establish and enforce policy. For example, the capacity of Malaysia’s government to require foreign investors to provide a specific amount of new employment and technical training to employees is rooted in the high level of organization of the government, including the bureaucracy. Malaysia has institutionalized a specific code of conduct, rules, requirements and regulations for foreign corporations. The government has also been able to enforce compliance with the codes because it is well organized and can track the operations of foreign investors, including the levels of domestic and international production and consumption as well as compliance with labor requirements and technology transfer quotas. Malaysia demonstrates that nondemocratic regimes with strong

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institutions can successfully attract and utilize foreign investment to promote domestic economic development. Malaysia has proven to be competent in good economic governance and deliberate in its policies pertaining to foreign investment and domestic development. The Malaysian government has been successful at attracting substantial foreign investment and has been equally adept at utilizing it to generate domestic growth. The failure of Nigeria to retain beneficial investments is, in large part, related to the nondemocratic history of corruption, discretionary treatment of foreign investments, disorganization, and failure to establish a coherent institutional framework. In contrast, Mahathir’s regime in Malaysia was well structured and highly efficient. In this regard Malaysia has more in common with the institutional effectiveness of Chile than the ineffectiveness of Nigeria. There are two significant differences between the interaction effects of institutional arrangements with foreign investment in Chile and those in Malaysia. First, the democratic administrations in Chile are more accountable to public demands to support domestic development programs such as infrastructure, education, health care, and public goods and services in accordance with the dominant social-democratic political orientations of the government and the majority party. This requires a substantial amount of government expenditure, which can be supported, in part, by increasing the government’s revenue from foreign investment. Chile promises transparency guarantees and nondiscretionary taxation, in addition to minimizing government regulations on production and consumption, in order to attract foreign investment and make it mutually profitable. In exchange for political transparency and economic freedom, foreign investors tolerate a nondiscretionary tax on their profits. Malaysia has a much lower level of democracy, which adversely affects the level of transparency, accountability, and nondiscretionary treatment of foreign investors. The Malaysian government also maintains a high level of regulation on the production and consumption of foreign investors. To compensate, in part, for the lack of economic freedom, Malaysia offers foreign investors financial incentives such as tax holidays. The extensive and often interminable tax holidays for foreign investors, in conjunction with government corruption, or kleptocracy, decrease the amount of government revenue Malaysia gains from foreign investments. However, the government is highly effective at extracting benefits other than tax revenue from foreign investment. The most substantial benefits are found in the labor requirements imposed on foreign investors; foreign firms must sign a legal contract with the gov-

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ernment that commits them to creating a significant amount of new employment and to hiring a relatively high proportion of native ethnic Malay. The contract also requires foreign investors to offer extensive skills training to employees, to expedite the promotion process, and to transfer a specific type and quantity of new technology to joint venture operations in Malaysia. India and Mexico are similar in their expeditious industrial liberalization and foreign investment arrangements. Both have developed automatic approval processes for foreign investments, eliminated almost all performance and production requirements, and established priority development zones to benefit foreign investors. Further, India and Mexico have a high enough institutional capacity to negotiate tax revenue from foreign investments, as does Chile. India taxes foreign firms at a comparatively high rate of 40 percent on average, Mexico offers tax breaks only to firms located in PDZs such as maquiladoras. Chile does not offer tax breaks to foreign firms. The primary difference is that India suffers high levels of corporate tax evasion because it lacks the institutional capacity to monitor and enforce its tax laws. India is able to attract foreign investors by agreeing to absorb many of the costs of infrastructure development. The government helps finance the construction of state-of-the-art business parks with high tech equipment and independent energy sources with backup generators. This accommodation increases the appeal and decreases the risk to foreign investors. The general domestic economic benefits for India are establishment of a comparative advantage in information and communication technology and a furthering of India’s integration into the global market. Foreign investment has also increased Mexico’s integration into the global economy. Mexico had been one of the most isolationist economies before the 1980s and is now one of the most liberal and export oriented. This process of liberalizaiton has been expedited by NAFTA, which determines almost every modern incentive and constraint for foreign investment in Mexico. One dynamic NAFTA has not been able to control is the sexenio, the dramatic economic downturn that has occurred after every presidential election in Mexico for over fifty years. The Mexican government is trying to use political institutions and economic policies to preempt or correct the sexenio because it has a negative effect on the domestic economy and foreign investment. The government has had to provide investment insurance for foreign investors to buffer the effects of the sexenio and to avoid divestment. There is optimism that improvements in democratic accountability and electoral competition in Mexico will correct the lack of confidence in

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the market that follows each electoral cycle. It is possible that improving the quality of democracy will decrease uncertainty, reduce divestment, and thereby minimize the effects of the sexenio, but this has yet to be successful. Foreign investment in the Americas, Asia, and Africa provides an informative comparative analysis to explain how variations in government negotiation strategies alter the benefits that developing countries are able to secure from hosting multinational corporations. To highlight the negotiation strategies that make GM investments more mutually beneficial in Latin America and Asia than in Africa, it is essential to compare the institutions that provide incentives and constraints for foreign investment. Chile has made a remarkable transition from the Pinochet dictatorship to the new democracy and economy, which now has one of the highest levels of foreign investment in Latin America. The Chilean government has focused on building capacity, accountability, and transparency, and has attracted and retained substantial foreign investments despite the deliberate lack of tax breaks, subsidies, and abatements typically used to attract foreign investors. Malaysia presents a contrasting, nondemocratic case. The government has a highly organized and effective bureaucracy, clear policies regarding the incentives and constraints on foreign investment, and a high success rate of attracting and utilizing foreign investment to promote domestic development. In order to illustrate the relative levels of democracy and institutional coherence between the country cases, Figure 9.1 compares the proximity of the African cases to the levels of democracy and governmental effectiveness of the American and Asian cases. Figure 9.1 compares the levels of democracy and institutional coherence of the regime cases in India, Chile, Malaysia, Mexico, Kenya, and Nigeria. Quadrant I represents countries that are democratic and have coherent institutions. The position of the case in that quadrant (high or low, left or right) indicates the “closeness” of the case to the highest or lowest levels of democracy and coherence. For example, Chile, located in quadrant II to indicate that it is democratic and has coherent institutions, is placed in the upper left corner of that quadrant to illustrate that it has relatively high levels of democracy and coherence. In comparison, Kenya is placed close to the line between democracy and nondemocracy, which represents its relatively low level of democracy. Another important piece of information included in this figure is the relative position of cases in comparison to each other. For example, Kenya is more democratic than Malaysia, although their elements of

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democracy are relatively close. A second comparison is that Malaysia has a higher level of institutional coherence than Kenya, which is marked by its location in the “effective institutions” quadrant. The figure illustrates four central relationships: (1) of the democratic cases, Chile has higher levels of democracy and institutional coherence than do Kenya, Mexico, and India; (2) of the nondemocratic cases, Malaysia has higher levels of institutional coherence than does Nigeria; (3) of the coherent cases, Chile has a relatively comparable level of institutional coherence with Malaysia; (4) of the incoherent cases, Kenya has a higher level of coherence than Nigeria. These indicators correspond to the investment outcomes: the benefits gained from foreign investment arrangements, illustrated in Figure 9.2. To summarize the information about investment outcomes in Figure 9.2, Chile and Mexico, two of the democratic cases, are the most successful at gaining direct benefits from foreign investment. India and Malaysia have also been successful at gaining relatively high levels of benefits from foreign investment. The primary difference between the high level of benefits gained by both Chile and Mexico versus India and Malaysia is that Chile and Mexico gained more direct benefits, such as government revenue, and India and Malaysia have gained more indirect benefits such as employment and skills training. Chile has increased its level of democracy and has institutionalized the investment process,

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Comparative Levels of Direct and Indirect Benefits from Foreign Investment

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both of which are attractive to foreign investors. The government has successfully passed legislation and made executive decrees that clarify the rules of foreign investment. The transparency of the investment process and the standardization of benefits, specifically the nondiscretionary tax rate, have generated relatively large amounts of foreign investment and government revenue from that investment. The high level of democracy also holds the government accountable for managing the investments properly, gaining domestic benefits, and distributing the benefits based on representation of interests. The revenue has been substantial enough to increase government spending on domestic development programs such as infrastructure, education, health, and provision of public goods and services. The other democratic case, Kenya, has not been able to pass a comparable amount of legislation that effectively institutionalizes the investment process or standardizes the benefits. Notwithstanding this, it has been able establish basic rules of operation for foreign investment. Kenya has also been able to extract government revenue, although not on the scale of Chile, and the government has been able to displace some of its costs by having foreign investors pay for infrastructure projects directly, which would otherwise be part of the government’s development expenditures.

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In contrast, both Malaysia and Nigeria, the nondemocratic cases, gain primarily indirect benefits. Malaysia has gained a high level of indirect benefits in comparison to Nigeria. The government entices foreign investors, in part, with generous tax holidays. Rather than maximizing the direct benefits of tax revenue, Malaysia requires foreign investors to provide a substantial amount of indirect benefits such as new employment, particularly for the ethnic Malay, and technical and managerial training. Nigeria, however, does not have the internal organization of the Malaysian bureaucracy nor the transparency and accountability of democratic cases. The government’s discretionary decisionmaking and lack of transparency discourage investors and distort benefits. Nigeria’s government has not institutionalized the investment process or standardized the benefits. The result is that outside the oil industry, foreign investment in Nigeria has produced minimal domestic benefits. In comparison, Kenya has offered maximum financial incentives to investors and has tried to expedite the administrative process of investing, but it has not been successful at gaining large numbers of foreign investors or gaining substantial benefits from investment contracts. One important difference between the democratic regimes in Kenya and Chile is that Kenya does not have a coherent institutional system to support or facilitate good economic governance. The legal rules, rights, and responsibilities of foreign investors are not clear, and the regulatory system is not transparent. Even within the Investment Promotions Center, established through parliamentary legislation, it is not clear what rules and regulations apply to what types of investments. The rules that are explicit are considered to over-regulate and discourage investment. Kenya also struggles with corruption in business and government, which distorts the distribution of profits for both the investor and the host country and has resulted in many corporate divestments from Kenya. The case of foreign investment in Kenya is not, however, as desperate as it appears to be in comparison with the success of Chile. Relative to other developing countries in the region of sub-Saharan Africa, Kenya has managed to attract several significant multinational corporations and has continued to make progress in economic liberalization. It has also been successful in promoting joint ventures between Kenyan and foreign companies. Through its cultivation of joint ventures, the government has managed to gain revenue, employment, and technology. In contrast, Nigeria has failed to attract or benefit from substantial foreign investment in the manufacturing sector and most other economic sectors outside the oil industry. Most foreign companies have been operating below capacity and not renewing contracts or reinvesting in

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Nigeria. It has been difficult to conduct business in Nigeria, owing to a lack of coherent institutional arrangements. The rules and regulations for foreign investment have been unclear and applied in a discretionary manner. Part of the legacy of the nondemocratic regimes and sporadic coup attempts has been that the Nigerian government lacks accountability, efficiency, and the capacity to enforce contracts with foreign investors. The case of nondemocratic regimes in Nigeria during the past twenty years demonstrates that nondemocracies with incoherent institutions have had little success at attracting foreign investment, and have gained almost no benefits from hosting the foreign investment that they do attract. A comparison of the successes and failures of the nondemocratic regimes in Nigeria and Malaysia demonstrates that nondemocratic regimes with strong, coherent institutions can effectively attract and utilize foreign investment for domestic development. Malaysia has proven to be competent in good economic governance, deliberate in its policies regarding foreign investment and domestic development, and equally efficacious at utilizing the investment to promote domestic development. The failure of Nigeria to retain beneficial investment relations is, in large part, related to the nondemocratic regime’s history of corruption, discretionary treatment of foreign investments, disorganization, and failure to establish a coherent institutional framework. In contrast, Mahathir’s regime in Malaysia is well structured and highly efficient, and has minimized corruption and maximized institutional coherence. In this regard, Malaysia has more in common with the institutional coherence of Chile than that of Nigeria. The largest difference in the interaction effects of institutional arrangements and foreign investment between Chile and Malaysia is that Chile minimizes government regulations and maximizes direct benefits, such as government revenue, while Malaysia maximizes both government regulations and indirect benefits, such as employment, skills training, and technology transfer. The most substantial benefits from investment for Malaysia are found in the labor requirements imposed on foreign investments. To invest in Malaysia, foreign investors must sign a legal contract with the government that commits them to providing a significant amount of new employment (the specific amount is set by the Malaysian government), and to employing a high proportion of native Malay. The contract additionally requires the investor to offer extensive skills training for employees and an expedited promotion process, and to transfer a specific type and quantity of new technology.

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Democratic regimes with high government effectives are the most successful at attracting and utilizing foreign investment for domestic development. Nondemocratic regimes with coherent institutions are effective at negotiating benefits from foreign investment; however, the benefits are primarily indirect. The comparative case study analysis demonstrates that several of the nondemocratic cases in the statistical analysis may rank low in their acquisition of direct benefits, but under closer examination these cases may rank high in their ability to gain indirect benefits. Of the democracies and nondemocracies without good governance, neither political type exhibits sufficient government capacity to attract, negotiate, or gain substantial benefits from hosting foreign investment. However, the democratic cases with ineffective governance fared better than the nondemocratic cases with ineffective governance in the statistical analysis and the case study in terms of their capacity to attract a small amount of foreign investment and use the revenue for domestic development programs. This indicates that in the case of foreign investment, democratic regimes with ineffective governments can extract minimal benefits such as small infrastructure-development projects, as in the case of Kenya, more effectively than nondemocracies with ineffective governments, such as Nigeria. It is important to recall, as emphasized earlier, that the level of democracy has a strong interaction effect with foreign investment, which helps explain why Chile (relatively high level of democracy) is more successful at attracting and utilizing foreign investment than is Kenya (relatively low level of democracy). One of the implications of the comparative case study is that the level of political development is a substantial indicator of the ability to gain benefits from foreign investment. Political development in the form of democratization and good governance improves the capacity of developing countries to utilize foreign investment for domestic growth.

Synopsis In conclusion, the capacity of governments to utilize foreign investment for domestic growth is contingent on the interaction effects of foreign investment with democratic and effective institutions. Developing countries must first improve the level of domestic institutional development in order to increase the capacity to negotiate and manage foreign investment to promote domestic economic growth. Previous work has focused too heavily on how to attract foreign investment, and not on how to use

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it. The fallacy is that an increase in the amount of foreign investment translates directly into an increase in economic growth. This work provides evidence that the amount of growth and government revenue from foreign investment is not solely a function of the total amount of foreign investment. The variation in growth and revenue from investment can be distorted and disproportionate to variation in the total amount of foreign investment. Deliberate institutional arrangements can serve as corrective mechanisms to market failures that distort the benefits of foreign investment. The divergent interests and disproportionate power of foreign investors and poor countries have created an imbalance of benefits. The benefits can be brought closer to an equilibrium through institutional mechanisms such as incentives and constraints, accountability and transparency, efficiency and efficacy, and nondiscretionary government policy. In order to use foreign investment effectively, to promote domestic economic growth, developing countries must first focus on political development.

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DATA ON THE RELEVANT VARIABLES ARE available for most develop-

ing countries from 1971 to 2006. Accordingly, the Cross-Sectional Time Series (CSTS) regression tests the data for these thirty-five years in 147 developing countries. Several basic conditions are addressed in order for the CSTS analysis to correctly establish correlation: covariance, autocorrelation, spuriousness, time order, and heteroskedasticity. Covariance is problematic if it exhibits collinearity or multicollinearity. These problems are minimized by eliminating one of the two variables that covary, such as corruption and accountability. Another common statistical problem in CSTS regression is autocorrelation—the correlation of the variables beyond the boundaries of the data set and the time constraints. The size of the Durbin-Watson statistic is used to identify the presence of autocorrelation in the analysis. Although autocorrelation is not highly problematic in this particular study, panel-corrected standard errors are used to make minor statistical corrections. Spuriousness exposes the possibility that the statistical relationship is caused or distorted by variables not specified in the model. To avoid a spurious relationship, this research includes control variables and provides a well-specified model. Nonspuriousness is achieved by controlling for two of the most plausible sources of spuriousness: population and purchasing-power parity. Time order is assumed for this research. The data are structured in time-series panels, chronologically by year. Time Series analysis can produce heteroskedasticity that results in biased and inconsistent results. This study resolves the problem of heteroskedasticity by maximizing the size of the database and using panel-corrected standard errors. The sta133

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tistical analysis has more time points than cases and variables, which minimizes the probability of heteroskedasticity. In addition, panel-corrected standard errors are used to correct for heteroskedasticity in the error term and provide better coefficient estimates. Finally, the complete data set is substantial, providing data on numerous political and economic variables for all developing countries over thirty-five years. The large size of the data set not only allows for effective corrections to heteroskedasticity and autocorrelation, it increases the degrees of freedom available for the analysis, which allows many variables to be tested simultaneously. This is one of the major contributions of this empirical analysis to the discipline of comparative political economy. Most studies have been limited by small data sets, and thus low degrees of freedom, and have been able to test very few variables per study. This study provides a more fully specified model and can test many variables in conjunction, revealing the interactions and the combined effects of the most relevant political and economic variables. Missing data are particularly problematic in studies of development owing to the lack of systematic record keeping and sporadic data collection in developing countries. Several methods are available for dealing with missing data: listwise deletion, substituting missing values with the mean values, and, unfortunately, guessing. A more sophisticated and less biased method is multiple imputation. Statisticians and methodologists have agreed on an approach to the problem of missing data based on the concept of multiple imputation, but most researchers in our field still use suboptimal methods because of a lack of skills training. However, advances in the multiple imputation algorithms and statistical programs leave few acceptable excuses for continuing to use suboptimal methods. Accordingly, this research employs the multiple imputation method for dealing with missing data. Five hundred iterations of multiple imputation are conducted for this research. The imputed data demonstrate rapid convergence, not pathological behavior. Rapid convergence indicates that the imputed values converge within the given amount of iterations and closely reflect the actual distribution. Pathological behavior would mean that the imputed values are sporadic, inaccurate, unrepresentative of the actual distribution, and are not valid candidates to replace missing values. However, pathological behavior did not occur in this study. The multiple imputations procedure for this study shows clear evidence of rapid convergence. This indicates that the multiple imputation iterations are successful and can be used in the statistical analysis.

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Measurement of Variables Economic growth (growGDP). Economic development is operationalized as the level of economic growth (growGDP) measured by annual change in gross domestic product (GDP) per capita. Direct benefit of foreign investment (govrev). The direct benefit of

foreign investment is operationalized as government revenue from foreign investment. Government revenue from foreign investment is the sum of income the government makes by taxing foreign investment (1) profits, (2) equity capital, (3) reinvestment of earnings, and (4) nonrepayable receipts from the sale of capital or land assets, as recorded by the World Bank, measured in constant US 2000 dollars. Indirect benefits of foreign investment (emplymt). The indirect bene-

fits from foreign investment are operationalized as an increase in employment, measured using World Investment Report and International Monetary Fund data. Level of foreign investment (forinvst; fdi; portfolio). The type of foreign investment is specified in the subcategories of direct investment and portfolio investment. Foreign direct investment includes the financing of capital gains, employment, infrastructure, and “feeder” industry. FDI is further specified as net inflows (fdiinflow) and stock (fdistock) to capture the dynamics of John Rothgeb and Volker Bornscheir’s findings that investment inflows have a positive short-term effect, while investment stocks have a negative long-term effect on overall growth in poor countries. FDI will be measured as the total value of international capital investments in constant US 2000 dollars, and all foreign investment data used in this research are compiled from the World Bank databases, the World Development Indicators, and the UNCTAD World Investment Reports. Portfolio investment is fluid; it can be transferred on a daily basis, has no capital gains, and is minimally integrated into the political structures of the country in which it is invested. The central focus of the study is on the capacity to negotiate FDI. Regime type (democ). Regime type is indicated by the level of democ-

racy or authoritarianism as determined by the net democracy score in the Polity IV dataset. Government effectiveness (goveffect). Government effectiveness is a measure that has been developed and refined for the World Bank by

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Daniel Kaufman, Aart Kraay, and Massimo Mastruzzi. Government effectiveness is operationalized as the capacity to formulate and implement policy. The variable is further specified as an index of variables that represent the “inputs” required for governments to produce and implement good policies and deliver public goods. A full explanation of the generation of the government effectiveness variable can be found in the World Bank publication Governance Matters III and is available at www.worldbank.org. Level of dependence (debt). This is measured as the level of depend-

ence on external funds, based on the World Investment Report of the International Monetary Fund. Dependence is measured as the sum of total external debt and foreign grants. Debt and foreign grants allow foreign creditors and investors to gain political and economic leverage, which can be used to decrease the autonomy of the dependent country. Political stability (stablty). Political stability is measured as the duration of the regime, regardless of regime type. Mark Gasiorowski’s data set is determined to be the most informative. It indicates the number of years each regime endured. The Polity II and IV data are used to support Gasiorowski’s data. The Polity data set uses a dichotomous variable to indicate a change in the regime (1 = change, 0 = no change), but it does not provide a “count” of the years of regime duration. The indication of change in the Polity data is superimposed on Gasiorowski’s data to verify that the regime changes match in both data sets; they do match. Gasiorowski’s data set is used for the statistical analysis because it provides more specific “counts” of the regime duration in years. Government intervention in the economy (ecfree; open). The level

of government intervention in the economy refers to trade “openness,” access to markets, and the level of regulation and restrictions on foreign investments. The variable ecfree indicates the level of domestic production and allocation via political mandates rather than private enterprise and markets. The variable open measures the level of freedom to trade with foreigners, specifically the presence or absence of financial and political barriers to international trade. Data for this variable are found in the Fraser Institute’s Index of Economic Freedom of the World 2000. Level of economic development (gdppc). The level of economic

development is measured by the gross domestic product per capita as recorded by the International Monetary Fund (US 2000 dollars).

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Taxation policy (inctax; intnltax). The domestic tax policy (inctax) is

operationalized as the total tax on domestic income, profits, and capital gains (percentage of revenue). The taxation policy for international investment (intnltax) is measured as the total taxes on international trade, profits, and capital gains (percentage of revenue). Detailed data are available for this variable from the International Monetary Fund’s Balance of Payment reports. Economic sectors (manufct; service; extractv; agriclt). The economic

sectors included in this study are the manufacturing, service, extractive/natural resource, and agricultural sectors. These specific sectors represent the dominant sectors in all developing countries, and the sectors that attract the most in foreign investment. The manufacturing sector is broken into two subcategories, advanced and basic, for the comparative case study analysis. The “value added” of each sector is the data required for the statistical analysis. The data are found in the International Monetary Fund and World Bank annual reports. The difference in the data between the two sources is extremely slight; the variation is negligible. The IMF data are used in order to remain consistent with the data used for most other variables in this study. Corruption (corrupt). Corruption is used as an intervening variable for

the statistical analysis. The Database on Political Institutions from the Development Research Group of the World Bank provides the latest and most consistent measure of corruption. Time (year). The time variable, year, is measured in one-year increments from 1971 to 2006. Country (name; region). Developing countries are referred to by name

and geographic region of location as determined by the World Bank. The International Monetary Fund and United Nations use the same general designations, but the World Bank provides more specific categories, particularly in Asia. Countries are divided into the following categories: sub-Saharan Africa (1), East Asia and the Pacific (2), South Asia (3), Latin America and the Caribbean (4), Central Europe and Central Asia (5), Middle East and North Africa (6), and Western Europe, United States, Canada (7). The numbers assigned to differentiate the regions are symbolic, not value laden. Population (popltn). Population is included as a control variable in

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the statistical analysis, measured in millions, as recorded by the International Monetary Fund. Purchasing power parity (pupopa). Used as a control variable, this

compares the price of the same good in different countries. Purchasing power parity is in equilibrium when the same amount of money can buy the same amount of goods or services in two different countries. Data are found for purchasing power parity in the World Bank Statistical reports, 1970–2006. The following system of regression equations summarizes the empirical models and observable hypotheses to be tested. 1. What are the effects of political and economic variables on the ability of developing countries to attract foreign investment?

Foreign investment = b 1 + b 2 (democ) + b 3 (goveffect) + b4(stablty) + b5(debtmil) + b6(ecfree) + b7(open) + b8(intnltax) + b 9 (gdppc) +b 10 (manmil) + b 11 (servmil) + b 12 (extract) + b13(agmil) + b14(popmil) + b15(pupopa) + e 2. What are the effects of the political and economic variables, including the amount of foreign investment, on domestic economic growth?

GrowGDP = b 1 + b 2(democ) + b 3(goveffect) + b 4(stablty) + b5(debt) + b6(ecfree) + b7(open) + b8(intnltax) + b9(fdiinflow) + b 10(fdistock) + b 11(portfolio) + b 12(manmil) + b 13(servmil) + b14(agmil) + b15(extract) + b16(popmil) + e 3. What are the interaction effects of political and economic variables with foreign investment on domestic economic growth?

GrowGDP = b 1 + b 2 (democ) + b 3 (goveffect) + b 4 (stablty) + b5(debt) + b6(ecfree) + b7(open) + b8(intnltax) + b9(fdiinflow) + b 10 (fdistock) + b 11 (portfolio) + b 12 (manmil) + b 13 (servmil) + b14(agmil) + b15(extract) + b16(popmil) + b19(dxi) + b20(cxi) + e The primary data sources for this research include the United Nations Conference on Trade and Development World Investment reports, available from 1975 to 2006; International Monetary Fund Balance of Payments reports, available from 1947 to 2006; World Bank Statistical Reports, available from 1947 to 2006; World Bank Global Development Finance reports, available 1950 to 2006; International Statistics yearbooks, available from 1970 to 2006; and the new Database on Political Institutions

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(DPI) from the Development Research Group of the World Bank. These are the most reliable and extensive data sets available on political institutions and political economy indicators at this time. Method 2: Comparative Case Study Analysis The statistical CSTS analysis is complemented by the comparative case study method, which serves three valuable purposes. First, case studies make the causal mechanisms more explicit than the statistical analysis of correlations coefficients. Second, case studies illustrate the wide variation in the success and failure of distinct models used in different countries. Third, in-depth analysis of the cases demonstrates the complexity and intricacy of the political and economic decisionmaking processes that contribute to the relation between foreign investment and development. Comparative case study analysis accomplishes these objectives by examining the contextual factors and integral details that are excluded from the large quantitative analysis. The cases are determined by using specific selection criteria and a systematic selection methodology. The selection criteria focus on variation in the independent variables, statistical significance of the interaction effects, falsifiability of the central statistical findings, and the impact of direct, not portfolio, foreign investment. The first specific selection criterion is that the political institutions and economic factors must vary. To be effective and accurate, this comparative case study requires the examination of states that are democratic and nondemocratic, institutions that are coherent and incoherent, economies that are strong and weak, and governments that have high and low levels of intervention in the economy. The cases for this study are not selected on the dependent variable, which would ensure a specific outcome. The cases are selected to provide maximum variation of the independent variables, specifically the interaction effect variables. In addition to representing variation, it is equally important to have a constant. The constant helps define what is and what is not explained. This analysis examines how variation in political and economic factors affects the capacity of domestic governments to negotiate foreign investment arrangements. It does not analyze corporate size or structure. Thus, corporate capacity is held constant while government capacity is varied. This is accomplished by studying a single corporation in a number of different countries with distinct political and economic environments. The study examines the outcomes based on variation in government capacity, not the outcomes based on corporate capacity.

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The second selection criterion is that the cases demonstrate the interaction effects found to be statistically significant in the data analysis. Interaction effects are more complex and less explicit than direct effects. They require more in-depth analysis and result in a more comprehensive explanation than do the effects that are introduced in correlation coefficients. The central theory of this study argues that regime type and government institutions interact with foreign investment to determine the outcome for domestic development. The statistical analysis shows significant results for the interaction effects of democracy and institutional coherence with foreign investment. The other variables have direct effects, which are less complex and are not considered to be the central focus of the comparative case study analysis. The cases for this study consist of a nondemocracy with coherent institutions, a nondemocracy with incoherent institutions, a democracy with coherent institutions, and a democracy with incoherent institutions. The third criterion is that the case study evidence is relatively stable, not incidental. This requires that the investment cases consist of direct capital investment, not portfolio. Direct capital investment implies a commitment to long-term profitability, capital development, employment, and interaction between foreign investors and host governments. In contrast, portfolio investment can change instantaneously on a daily or hourly basis, and is too fluid to meet the criteria established for this research. The qualitative case analysis is designed to complement the quantitative data analysis, which spans 15–30 years. In order for the analyses to be comparable, the cases should include investments that have been active for approximately 15–30 years. Direct capital investment can be analyzed for change over time, which clarifies the causal mechanisms in the relationship between investment and development. In sum, the final selection criteria are these: (1) the foreign investment must be a long-term, direct, capital investment; (2) the foreign investment needs to have a constant—a single corporation that invests across countries—in order to test the effects of government capacity, not corporate capacity; (3) the country cases must represent each of the four variations of interaction effects: democracy with coherent institutions, democracy with incoherent institutions, nondemocracy with coherent institutions, and nondemocracy with incoherent institutions. The comparative cases for the qualitative analysis are as follows: Kenya. The attack on democratic institutions under Moi’s regime, the

divestment of foreign firms, and the renewal of the democratic transition (emphasis on executive regimes: Moi to Kibaki).

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Nigeria. The progression of coups and military rule, the intermittent

attempts to establish democracy, the divestment of foreign firms, and the failure to diversify the market outside the oil industry (emphasis on executive regimes: Buhari to Yar’Adua). India. The consolidation of multiparty democracy and the transition to

an export-oriented development strategy (emphasis on executive regimes: Rao to Singh). Malaysia. The process of economic modernization and the development

of a highly structured bureaucracy (emphasis on executive regimes: Mahathir to Abdullah). Chile. The transition to democracy after Pinochet’s regime and the

adjustment to neoliberal economic reforms (emphasis on executive regimes: Pinochet to Bachelet). Mexico. The evolution from a single-party to a multiparty democracy,

the transition from import substitution to export-oriented industrialization, and the neoliberal adjustments to NAFTA (emphasis on executive regimes: Zedillo to Calderon). The elements of comparison are consistent and systematic for all cases. Each case is evaluated based on four analytical categories and the specific indicators within those categories. The four analytical categories and comparative indicators are the following: 1. Incentives and Constraints Code of conduct, investment promotion agency, regulation of production and consumption, tax policy, labor pool, market access, corruption, discretionary policy application, transparency of decisionmaking, performance requirements, infrastructure, raw materials, environmental externalities, and other sources of leverage in negotiations 2. Direct and Indirect Benefits Government revenue, multinational corporate profits, expansion of industrial sector, increase in value-added exports (manufactured goods), new employment, employee benefits (health insurance), skills training, technology transfer, infrastructure development, service provision, financial and humanitarian aid programs 3. Specific investment arrangements with General Motors, unique to each country case 4. Structural change and catalysts for renegotiation, unique to each case.

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Abacha, Sani, 60–61 Abiola, Moshood, 60 Abubakar, Abdusalam, 61 Africa, comparative lack of foreign investment in, 6, 16, 47–48 See also Kenya; Nigeria Afro Asian Satellite Communications, 72 Agricultural sector, 28–29, 48 AngloGold, 48 Arbetman, Marina, 25 Argentina, 97 Asia during 1980s/1990s, substantial increase of foreign investment in, 16 Asian (East) Financial Crisis of 1997, 16, 19, 72, 87, 94 Association of Southeast Asian Nations (ASEAN), 91–92 Australia, 100 Authoritarian regimes, 19 Aylwin, Patricio, 99, 100, 103 Babangida, Ibrahim, 60 Bachelet, Michelle, 100 Bangladesh, 72 Bargaining power thesis, 14 bin Mohamad, Mathathir, 85 Birla Group, 80 BMW, 48 Bornscheir, Volker, 135 Botswana, 47 BP (British Petroleum), 72 Brazil, 15, 28, 98, 99 BRIC countries (Brazil, Russia, India, China), 15–16, 28

Buhari, Muhammad, 60 Burma, 72 Burundi, 55 Calderon, Felipe, 107 Canada, 100 Capgemini, 81 Capitalism as common denominator for international economic activity, 35 CARE, 57 Chile: background and structural change, 99–100; Central Bank’s Foreign Exchange Regulations, 101; coalition, rule through, 99; comparative case for qualitative analysis, 42; corruption, 101–102; Decree Law 600, 100–101; democracy and institutional coherence, 125–126, 130; democratic development and economic growth, 98–100; economic liberalization, rapid transition to, 97; education and training centers, 102; free enterprise/trade zones, 102; General Motors Chile Limitada, effects on, 102–103; incentives/constraints for/on foreign investment, 100–102; indirect/direct benefits from foreign investment, comparative levels of, 126–130; innovative approach to foreign investment, 98; labor/working conditions/requirements, 38; Malaysia and, comparing, 123–124; Mexico compared to, 115; OPA Law (Ley de OPA), 101, 103; outperformed most of Latin America,

155

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39–40; overview, 141; policy valence, 99; renegotiation as a common process, 35; success story, 120–121; taxes, 22, 110, 115; welcoming attitude toward foreign investment, 100 China, 16, 28, 72, 82–83 Citibank, 72 Coase, Ronald, 4 Coca-Cola, 48, 105 Colonial legacy in Africa, 48 Command economies, economic success of, 19 Common Market for Eastern and Southern Africa (COMESA), 55 Comparative case study (CCS), 39–44, 119–120, 139–141 Compuware, 81 ConAgra, 48 Corruption: Chile, 101–102; India, 77; Kenya, 54; Malaysia, 90; Mexico, 110–111; overview, 21, 137 See also Nigeria Covisint, 81 Cross-Sectional Time Series (CSTS), 17–18, 29, 119–120, 133 Database on Political Institutions (DPI), 138–139 Data issues, 133–134 De Beers, 48 Del Monte, 48 Democracy and institutional coherence, 125–126, 130 Democratic/nondemocratic governments and direct/indirect benefits, 19, 98–100, 120, 121, 126–130 Desmukh, Vilasrao, 81 Developing world relies on global markets to stimulate growth/wealth, 1–2 See also Foreign investment as a development strategy; Political economy of development; individual countries Development strategy, foreign investment as a. See Foreign investment as a development strategy; Political economy of development; individual countries Diffuse institutions, 20 Direct/indirect benefits from foreign

investment, comparative levels of, 126–130, 135 Domestic development. See Foreign investment as a development strategy; Political economy of development; individual countries Dow Chemicals, 48 Durbin-Watson statistic, 133 Economic determinism, the theory of, 22 Economic development, level of, 24–25, 136 Economic sectors’ differing ability to benefit from foreign investment, 27–29, 137 Elf, 48 Encarnation, Louis, 20 Environmental issues, 112–113 Ethiopia, 55 Europe, 16, 48 Exploitation, how foreign investment leads to, 2 Extractive sector, 28, 47, 62, 109 Exxon, 37 Fogel, Robert, 4 Ford, 37, 105 Foreign investment as a development strategy: advocates of using, 12; Africa’s troubles with, 6; ambiguous/ambitious, modern concept of development as both, 11; autonomy from foreign economic leverage, institutional, 27; Chile as a success story, 120–121; comparative studies used to analyze, 39–44; corruption, 21; Cross-Sectional Time Series, 17–18; democracy and institutional coherence, 125–126, 130; direct/indirect benefits from foreign investment, 126–130, 135; divergent interests of investors and host governments, 13–15; domestic development and foreign investment, relationship between, 1–2; economic development, level of, 24–25; economic environment influencing investment arrangements, 22–29; economic growth as main goal of host governments, 13; economic sec-

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Index tors’ differing ability to benefit from foreign investment, 27–29; General Motors, the global operations of, 36–39; globalization directly affecting role of foreign investment in domestic development, 35–36, 117; goals of development, 11; government effectiveness, 20, 31; government intervention in the economy, 22–24; helps/hinders economic development, debate whether foreign investment, 12; increase (worldwide) in foreign direct and portfolio investment, 16; India and Mexico, comparing, 124–125; interaction effects of political economy/foreign investment/growth, 29–32, 119–120; international economic freedom, 24; legislation used to maximize benefits for both investor and host, 118; level of foreign investment, overall, 31–32; Malaysia and Chile, comparing, 123–124; Malaysia’s organized hierarchy, 122–123; negotiations between investors/hosts, variation in capacity for equal, 14, 32, 125; opponents of using, 12–13; overview, 11–13; political actors, foreign investors acting as, 36; political institutions on investment arrangements, effects of, 18–21, 117, 121–122; political stability, 21, 32; profit maximization as main goal of foreign investment, 13; regime type, the effect of, 18–20, 117–120; renegotiation as a common process, 35; structural change and the investment, 34–35; success/failure of, variation in the, 117; summary/conclusions, 33–34, 130–131; synergistic model, 119–120; taxation, 25–26; total foreign investment in world regions (1970–2000), 16–17; trends in foreign investment, 15–17; utilization of foreign investment, effective, 117–119 See also Political economy of development; individual countries Fox, Vicente, 107 Fragmented institutions, 20 Free enterprise/trade zones: Chile, 102; disputes concerning, 5–6; India,

157 78–79; Malaysia, 89–90 See also Mexico

Gandhi, Indira, 74 Gandhi, Mahatma, 74 Gandhi, Rajiv, 74 General Electric, 5, 37, 72, 105 General Motors: Chevrolet Indian Revolution, 5, 82, 93; Chile, 102–103; constant variable in the comparative case study, 43–44; global operations of, 36–39; India, 79–83; Kenya, 54–57; labor requirements, complying with new, 38; Malaysia, 90–93; Mexico, 111–114; Nigeria, 65–67; North America, suffering economic volatility in, 97; reorganization of overseas operations, 38; setbacks (economic) in early 2000s, 27 Germany, 51 Global Development Finance Report, 3 Globalization, 1–2, 35–36, 85, 117 See also Foreign investment as a development strategy; Political economy of development; individual countries “Globalization, Growth and Poverty: Building an Inclusive World Economy,” 114 Government effectiveness, 20, 31, 135–136 See also Kenya Hagopian, Frances, 3 Hewlett-Packard, 81 Highly Indebted Poor Countries (HIPC), 15 High tech investment. See India; Malaysia Hirschman, Albert, 14 HIV/AIDS, 56 Hughes Space and Communications Company, 92 Human Rights Watch, 50, 111 Huntington, Samuel, 3, 11 IBM (International Business Machines), 5, 72, 81 India: background and structural change, 74–75; Bhartiya Janta Party, 74–75; a BRIC country, 15, 28; Chevrolet Indian Revolution, 5, 82, 93; China compared to, 82–83; Code

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of Criminal Procedures, 77; Companies Act, 76–77; comparative case for qualitative analysis, 42; corruption, 77; education and training centers, 71, 72, 77–78; Foreign Investment Promotion Commission, 75–76, 80; free enterprise/trade zones, 78–79; General Motors India Private Limited, effects on, 79–83; Global Aid program, GM’s, 81–82; High Tech Cities, 71, 76; incentives/constraints for/on foreign investment, 75–79; indirect/direct benefits from foreign investment, comparative levels of, 126; information technology suppliers, 81; infrastructure costs, 73; liberal economic policy, exceptions to, 79; Maharashtra Industrial Development Corporation, 80–81; Malaysia compared to, 93–94; Mexico compared to, 124–125; negotiations between investors/hosts, variation in capacity for equal, 76–77; overview, 40–41, 141; political instability, 72, 73; powerhouse, a burgeoning economic, 72–73; Prevention of Corruption Act, 77; renegotiation as a common process, 35; skilled labor force, 77; tax base, large labor pool and small, 73, 78; tradeoffs in costs/benefits of hosting foreign investment, 73; transparency in the investment process and regulatory system, 77; United States and, trade relationship between, 75; water shortage, acute, 82; welcoming to foreign investment, 5 Indian Institute of Technology (“Millionaire University”), 71, 72, 77 Indirect/direct benefits from foreign investment, comparative levels of, 126–130, 135 Indonesia, 72 Information technology (IT) suppliers, 81 International Labour Organization (ILO), 114 International Monetary Fund (IMF), 136, 138 International Statistics, 138

Italy, 100 Japan, 54, 55, 100 Joint ventures, 66–67, 91 See also Malaysia Kashmir, 74 Kaufman, Daniel, 136 Kennedy, Alan W., 103 Kenya: background and structural change, 49–50; comparative case for qualitative analysis, 42; corruption, 54; democracy and economic growth, transition to multiparty, 48; democracy and institutional coherence, 125–126, 130; democratic reforms, 50; economic reforms of 1993, 53; Export Processing Zones, 51–52; extractive sector, 62; Foreign Investment Act, 52; Foreign Investment Protection Act, 52; General Motors Kenya Limited, the effects on, 54–57; Global Aid program, GM’s, 56–57; HIV/AIDS, 56; incentives/constraints for/on foreign investment, 50–54; indirect/direct benefits from foreign investment, comparative levels of, 127, 130; Industrial and Commercial Development Corporation, 54; Industrial and Community Development Company Investment Company, 54–55; infrastructure costs, 55, 57; institutional incoherence, 51, 121–122; Investment Promotion Center, 48, 50; Kenya African National Union, 50; Kenya AntiCorruption Authority, 54; labor/working conditions/requirements, 52–53; legal code for foreign investment, no, 51; military rule, 60–61; National Republican Convention, 60; negotiations between investors/hosts, variation in capacity for equal, 48–49, 55; overregulated market system, considered to have a, 53–54; overview, 40, 140; Prevention of Corruption Act, 54; renegotiation as a common process, 35; Revenue Authority, 52; Social Democratic Party, 60; summary/conclusions, 57–58

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Index Kenyatta, Jomo, 49–50 Keohane, Robert, 14 Kibaki, Mwai, 50 Kodak, 48 Kraay, Aart, 136 Kugler, Jacek, 25 Labor/working conditions/requirements: Chile, 38; Kenya, 52–53; Malaysia, 38, 92; Mexico, 113; Nigeria, 64 Laissez-faire economic theory, 22–23 Lash, Jonathan, 113 Latin American Pumas, 97 See also Chile; Mexico Limongi, Fernando, 19 Lopez Obrero, Andres Manuel, 107 Malaysia: Asian (East) Financial Crisis of 1997, insulated from, 87; Association of Southeast Asian Nations free trade area, 91–92; background and structural change, 86–87; Chile compared to, 123–124; comparative case for qualitative analysis, 42; corruption, 90; democracy and institutional coherence, 125–126, 130; domestic market, tight management of the, 85, 87; economic liberalization and international market system, 85, 87; education and training programs, 92–93; electronics/ telecommunications technologies, high-end consumer, 72; export -oriented industrialization strategy, 87–88; free enterprise/trade zones, 5–6, 89–90; General Motors Malaysia, effects on, 90–93; Global Aid program, GM’s, 92–93; globalization, balancing the various elements of, 85; incentives/constraints for/on foreign investment, 87–90; India compared to, 93–94; indirect/ direct benefits from foreign investment, comparative levels of, 126, 129; Industrial Coordination Act of 1975, 88; institutional hierarchy, a highly organized, 122–123; joint ventures between foreign and Malaysian corporations, 89; labor/ working conditions/requirements, 38, 92; Malaysian Industrial Develop-

159

ment Authority, 88–91; Ministry of Domestic Trade and Consumer Affairs, 89; Multimedia Super Corridor, 89; National Economic Recovery Plan, 89; overview, 41, 141; Promotion of Investments Act of 1986, 88–89; regulation of multinationals, code of conduct and, 86; renegotiation as a common process, 35; Second Industrial Master Plan 1996–2005, 88; summary/conclusions, 93–94; tax arrangements for foreign investors, 87, 92; transparency in the investment process and regulatory system, 90; United Malays National Organization, 86; welcoming to foreign investment, 5 Manuel Lopez Obrero, Andres, 107 Manufacturing sector, 28–29, 48 Maquiladoras, 5, 107, 111, 112, 114 “Market Research Report,” 59 Mastruzzi, Massimo, 136 Measurement of variables, 135–139 Mexico: automatic approval policy for foreign investments, 108; background and structural change, 106–107; Chile compared to, 115; comparative case for qualitative analysis, 42; constitutional amendments of 1993/1995/1997, 108; corruption, 110–111; democracy and institutional coherence, 125–126, 130; disputes with foreign investors, 5; environmental practices foreign industries, 112–113; extractive sector, 109; family-owned businesses and small retailers, domination of, 107; financial crises at end of government administrations, 106; General Motors de Mexico, effects on, 111–114; Green House Gas Program, 112–113; incentives/constraints for/on foreign investment, 107–111; India compared to, 124–125; Investment Commission, 108; labor/working conditions/ requirements, 113; laws, foreign investment, 107, 108; maquiladoras, 5, 107, 111, 112, 114; micro and macrolevel benefits, 106; NAFTA, investment in Mexico pervasively

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influenced by, 105–106, 111–112; NAFTA, readjustment after implementation of, 97; oil, no privatization of, 109; outperformed most of Latin America, 39; overview, 141; Partido Accion Nacional, 106–107; Partido Revolucionario Institucional, 106; Partnership for Prosperity-Good Partner Award, 114; performance requirement for foreign firms, 110; priority development zones, 109– 112; privatization policy, 108–109; renegotiation as a common process, 35; single-party history of, 106–107; summary/conclusions, 114–115; taxes, 110, 115; transparency in the investment process and regulatory system, 110–111, 114; women, discriminatory hiring/firing practices concerning, 113–114 Mitsui, 72 Moi, Daniel arap, 40, 50, 57–58 Monsanto, 48 Motorola, 105 Mozambique, 55 Myers, Lynn C., 103 NAFTA. See North American Free Trade Agreement National Power and the Structure of Foreign Trade (Hirschman), 14 Negotiations between investors/hosts, variation in capacity for equal, 14, 32, 76–77, 125 See also Kenya Nelson, Joan, 20 Neoclassical economic strategy, 23 Nestle, 5, 72 Nigeria: Allied Matters Act of 1990, 64, 65; background and structural change, 60–61; Companies and Allied Matters Decree of 1990, 62; comparative case for qualitative analysis, 42; corrupt leadership, political system pervaded by, 59–60; Corrupt Practices and Other Related Offenses Act, 65; deregulation, guided, 64–65; Enterprise Promotion Act, 63; Export Processing Zones, 63–64; General Motors Nigeria Limited, effects on, 65–67; Global Aid program, GM’s, 67; incentives/constraints for/on foreign investment, 61–65; indirect/direct benefits from

foreign investment, comparative levels of, 128–130; Industrial Development Act of 1971, 62; Industrial Policy of Nigeria Act of 1990, 62; infrastructure costs, 61; Investment Promotions Commission, 62–63; joint ventures, 66–67, 91; labor/ working conditions/requirements, 64; Market/Trade Promotion agency, 63; National Economic Recovery Fund, 64; National Office for Technology Acquisition, 64; Nigerian Investment Promotion Commission, 62; overview, 41, 141; renegotiation as a common process, 35; Securities and Exchange Act of 1988, 62; Structural Adjustment Program, 64; summary/conclusions, 67–68; Trade Contracts Office, 63; transparency in the investment process and regulatory system, 65 Nike, 48 Nokia, 5, 72 North, Douglass, 4 North American Free Trade Agreement (NAFTA), 5, 39, 97, 98 See also Mexico Nye, Joseph, 14 Obasanjo, Olusegun, 61 Organization of American States (OAS), 101–102 Organski, A. F. K., 5 Pakistan, 74 Pepsi, 105 Perodua, 91 Pinochet, Augusto, 99, 103 Political economy of development: African countries having trouble acquiring foreign investment, 6; exploitation, how foreign investment leads to, 2; foreign investment and domestic development, relationship between, 1–2; intervention in the economy, government, 22–24, 136; negotiation of initial investment arrangements, government, 2; overview of book, 6–7; political institutions influencing benefits/concessions, 3–4, 14, 18–21, 117, 121– 122; reception for foreign investment, mixed, 5–6; role of political

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Index economy, 4–5; stability/instability, political, 21, 32, 72, 73, 136; strategies for gaining greater benefits from foreign investment, 2; utilizing foreign investment to promote domestic development, 2, 15, 117–119 See also Foreign investment as a development strategy; individual countries “Political Regimes and Economic Growth” (Przeworski & Limongi), 19 Portfolio investment, 16, 28 Power, outcomes of negotiations as a function of relative power, 14 Power and Interdependence (Keohane & Nye), 14 PowerGen, 72 Profit maximization as main goal of foreign investment, 13 Proton, 91 Przeworski, Adam, 19 Purchasing power parity, 138–139 Rao, P. V. Narasimha, 74, 75 REA Holdings, 48 Regime type, the effect of, 18–20, 117–120, 135 Relative Political Extraction, 25 Renegotiation as a common process, 35 Rothgeb, John, 135 Royal Dutch Shell, 72 Russia, 15, 16, 28 Rwanda, 55 Securities and Exchange Commission (SEC), 37 Sen, Amartya, 1 Service sector, 28–29 Singh, Mammohan, 74 South Africa, 47 Spain, 100 Spuriousness as a statistical problem, 133 Structural change and the investment environment, 34–35 See also background listings under individual countries Sunbeam, 111 Synergistic model, 119–120 Tanzania, 55

161

Taxation: Chile, 22, 110, 115; conventional wisdom on, 22; foreign profits, debate on taxing, 25–26; India, 73, 78; Malaysia, 87, 92; Mexico, 110, 115; overview, 137; paradox presented by, 25 Thailand, 72 Time dimension to negotiating benefits/concessions of foreign investment, 14 Time-Series regression tests, 17–18, 29, 119–120, 133 TotalFina, 48 Toyota, 91 Transparency International, 90 Uganda, 55 UNICEF, 57 Unilever, 48 United Auto Workers (UAW), 38 United Kingdom, 51, 100 United Nations Conference on Trade and Development (UNCTAD), 13, 138 United States, 51, 75, 78, 100 See also Mexico United States Agency for International Development (USAID), 76 United States and Foreign Commercial Service, 59 Vajpayee, Behari, 74 Volkswagen, 105 Wells, Dennis, 20 Williamson Tea, 48 Wipro, 81 Women, discriminatory hiring/firing practices concerning, 113–114 World Bank, 3, 23, 76, 114, 138, 139 World Business Council for Sustainable Development, 112 World Investment Report, 13 World Resources Institute, 112 World Trade Organization (WTO), 74, 109 Zambia, 55 Zedillo, Ernesto, 106 Zenith, 111 Zimbabwe, 55

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About the Book

HOW IS IT THAT, IN A time of unprecedented global opulence and mar-

ket activity, billions of dollars flow through the developing world without altering its reality of poverty and scarcity? Jenny Kehl explores the crucial relationship between foreign direct investment and domestic development, focusing on the wide variation in the capacity of governments to negotiate FDI to the advantage of their citizens. To isolate the influence of political factors, Kehl examines one of the largest foreign investors, General Motors, in its relations with six host countries representing a range of political systems. Her cases, along with her larger statistical study, soundly refute conventional wisdom, demonstrating that the essential elements for successfully using FDI for development are political, not economic, and pointing to the political strategies and institutions that can best maximize the domestic benefits of foreign investment. Jenny Rebecca Kehl is assistant professor of political science at Rutgers University–Camden and coordinator of the university’s International Public Service and Development Program.

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