Is there a way to sustainable investment?

Diplomarbeit von Katja Treichel

Introduction:

The issue of foreign direct investment (FDI) as one of the key features of globalisation, continues to attract widespread attention, particularly since its rapid increase in the last decade. While some see FDI as a panacea for overcoming poverty, others point precisely to the opposite and recall the negative image often connected to multinational corporations (MNCs) embodied in child labour, environmental catastrophes, and exploitation of cheap work force. Opinions on the benefits of FDI for development differ considerably, but so does the observed reality. In some countries FDI has, in fact, contributed to economic progress and fallen poverty rates. Other countries by contrast, have not been able to reap the repeatedly praised fruits of investment flows such as job creation and technological spillovers, or did not even attract significant amounts of FDI.

But in the highly inter-dependent and inter-connected world that we live in now, extreme views cannot and should not set the tone for future debates. Neither the retreat into isolated and protectionist patterns nor the advocacy of a downright neo-liberal credo seem to be viable options. For one thing, FDI has outstripped official development aid in numbers and no single country has lifted itself out of poverty in the last 50 years without integrating into the world market. For another, simple liberalisation measures have not always increased FDI flows into host developing countries and where they did, FDI flows have not automatically brought with them the desired benefits for development. The term development should be understood in a sustainable sense and thus, goes far beyond the rise of the gross national product per capita. It means, according to the frequently quoted Brundtland report, ‘development that meets the needs of the present without comprising the ability of future generations to meet their own needs’.

Without neglecting the importance of raising income levels, it puts special emphasis on enhancing the skills and competencies of people who should harness and shape their ecological, economic and social environment in sustainable ways. Crucial with this understanding of development is on one hand, its long-term perspective, and on the other, the interplay between the economic, social and environmental dimension, both making any action oriented towards development a highly complex matter. As a consequence, the presumption that all kinds of investment flows and activities of multinational corporations in developing countries lead per se to development is rather simplistic. While the buzz-word ‘sustainable development’ has penetrated books, business reports, advertisement, government statements, newspaper articles and conferences all over the world, it still has not been sufficiently integrated into policy approaches on FDI. But given the interconnection of the three dimensions mentioned before, it is clear that international businesses are important for and do significantly determine the sustainability of future development.

Embedded in this line of reasoning, the overarching question of this paper is how foreign direct investment can be made more relevant in terms of sustainable development. Investigations into the effects and implications of FDI have undoubtedly been on the agenda for a long period of time and past findings remain relevant. However, there have been important paradigm shifts influencing the debate about approaches to FDI-led development. First of all, research on the impacts of foreign direct investment tend to increasingly focus on differences between the various forms of investment and the characteristics and strategies of MNCs. As a consequence, the quantity of FDI looses its standing as ‘sufficient condition for development’ and the quality of FDI moves into the centre of attention. The concept of quality here refers to sustainable development and will be further examined in the fourth part of the paper under the hypothesis that future development will depend to a large extent on the quality of FDI and not primarily on the quantity. A further paradigm shift concerns the number and relationships of the actors involved. In contrast to development approaches of the past that have been too narrowly focused either on the role of the state or the role of international businesses, more recent approaches take into account both actors as being crucial for development and draw special attention to their interplay. This shift of paradigms can be attributed to failures of past development strategies such as import-substitution, the latest political developments such as the collapse of states followed by humanitarian emergencies (e.g. Rwanda, Sudan) as well as to economic success stories such as those of Singapore and Malaysia where FDI has played a major role, or of South Korea where the state has been the decisive actor pushing for developmental progress. The state and MNCs alike are no longer seen as obstacles but rather as facilitators for economic growth, provided that they act in a complementary way. It has been recognised that both market and governmental failures have to be taken into account when defining what governments and international businesses should do and how the should it, in order to spur sustainable development.

However, if future development strategies are to bring real progress, the number of actors cannot be reduced to governments and international businesses for the following reasons. Governments as well as multinational enterprises are currently facing a crisis of public trust. The Strategy One survey for Edelmann Global Communications, conducted in June 2000, serves as a good illustration. ‘(I)nterviewees were asked who could best be trusted on key issues such as environment, human rights and health’. Only 15 percent of the interviewees trusted governments on these issues and even a lesser percent replied in the affirmative for corporations. This result is not surprising given the continuing exposure of business scandals, disclosures of corruption and the fiscal crisis of the western welfare state. Interestingly, the majority of the interviewees (50-60 percent) granted their trust to non-governmental organisations (NGOs), despite their critical lack of legitimacy and accountability. NGOs have mushroomed in the last years picking up various issues people are concerned about. More and more E-enabled NGOs integrate at the international level and establish networks in order to give their concerns a voice in global debates on developmental and other issues. They sometimes even effectively influence politics in the international arena as it was the case with the trade talks at Cancun where thousands of anti-globalisations activists and several NGOs supported some developing countries in bringing negotiations to a halt without any agreement in September 2003.

Whether the outcomes of NGO activities are desirable or not, their impact on global affairs cannot and should not be ignored. New technologies have enabled them to form national and transnational coalitions, and future innovations will provide them with even more refined tools of communication. Against this background, it is clear that development strategies will have to acknowledge the role and capabilities of NGOs, resulting them to a beneficial actor in the field. But what exactly is this (new) role that NGOs are to take on in the realm of sustainable investment? What could their responsibilities be and how can they be matched up to the tasks of governments and strategies of MNCs, in order to make investment more sustainable?

These questions will be approached in chapter 5, framed in a discussion on changing conditions and emerging opportunities in the 21st century. It will become apparent that the state is key actor for enabling NGOs and MNCs to contribute to national development plans that are geared to sustainability. While the roles of governments, NGOs and MNCs alike remain clearly defined and distinguished, their interplay is losing the rigidity, which past development strategies attributed to it. Pioneering collaborative approaches are surfacing. Some of them will be presented, in order to give the reader an idea of what is possible and where future strategies could be resumed.

For a better understanding of the current debate, chapter 3 will explore theories that have had a major influence on development strategies in relation to FDI and will put them in perspective with more recent theoretical approaches. While neo-liberal, modernisation theorists saw FDI as the engine of growth being hindered to fully accelerate due to dirigiste state interventions, dependency theorists considered FDI to be a form of neo-colonial exploitation. Since the middle of the 1980s, a more sceptical position has evolved which neither blames the state nor large international enterprises for underdevelopment. It takes on a more balanced view, although it is still more an ongoing research-programme than a fully matured theory. Thus, it leaves various questions open and gives room to new practical and theoretical considerations, for example in relation to NGOs’ capabilities, government tasks and responsibilities of MNCs.

In order to give the discussion a clear framework, the succeeding chapter will define in greater detail the relevant terms and concepts.

Table of contents:

Text Sample:

Chapter 4.2.3 Social qualities of FDI:

As touched upon earlier, FDI may also involve the transfer of advanced technologies, skills and know-how to the host economy. These transfers have the potential to spur economic growth by boosting the efficiency and productivity of the majority of firms in the host economy, not only of firms that are directly engaged in FDI-related activities. This spillover process of knowledge and technology however, does not transpire automatically with the injection of foreign capital into the host country. If MNCs ‘operate in enclaves where neither products nor technologies have much in common with those of local firms (…) there may be little scope for learning, and spillovers may not materialize’.

The transfer and diffusion of technology, skills and know-how works through several channels: Backward, forward and collaborative linkages, labour turnover, and demonstration effects.

Backward linkages with suppliers are seen as one of most important channels through which superior know-how and technologies can spill over to the host economy. When MNC affiliates procure production inputs through local enterprises, they are generally interested in keeping their quality standards. As a result, they provide technical equipment and assistance, market information, product specification and management training to local enterprises, in order to help them meeting the quality standards of their output. The intensity of spillovers via backward linkages is, however, conditioned by various issues.

First of all and as a logical consequence, it depends on the strength and extent of linkage formation. If MNC affiliates decide to import the majority of their production inputs rather than to purchase them on local markets, backward spillovers remain insignificant.

Secondly, in cases where MNCs set up operations with the objective of exploiting local resources (e.g. raw materials) on a short-term basis, and settle for using locally available technologies, again no major spillover effects can emerge. In contrast, MNCs with longer-term investment motives (e.g. domestic-market oriented affiliates) tend to be more active in developing local suppliers and often expand local supplier networks over time.

Thirdly and most importantly, if knowledge and technology gaps between local enterprises and MNCs are too big, an upgrading of local enterprises and, thus, an advancement of the domestic economy is unlikely to take place for the following reasons: MNCs in more sophisticated industries such as electronics may not be attracted by the potential host country in the first place (despite far-reaching tax concessions or other incentives), or MNC affiliates will simply not follow outsourcing strategies that involve more superior parts of the value chain. Furthermore, local enterprises might not be able to decodify accessible knowledge and adapt technologies in ways that benefit the development of the local market.

The latter is often referred to as ‘absorptive capacity of host country economic agents’, which can be defined as the ‘ability to absorb, internalize and utilize the knowledge potentially made available to them’ (ibid.:10). The concept of absorptive capacity implies that a certain threshold of knowledge is required in order to harness some of the FDI-induced potentials and throws light on the question as to why the poorest and technologically most backward developing countries have failed (so far) in emerging as beneficiaries of the latest global FDI surges. Yet, absorptive capacity should be understood as a dynamic and systemic concept. This means that backward countries can increase their absorptive capacity over time under the provision that they invest in their own capacity building (e.g. by improving their educational systems) and use other channels of knowledge-transfers (e.g. international forums). Referring back to local enterprises, their absorptive capacity will be shaped by their own efforts and capability to upgrade their knowledge stock by interactions with other economic actors, by the availability of educated people, and, hence, by government policies that are aimed at improving local skills and human resource capabilities.

The concept of absorptive capacity is also applicable to other spillover mechanisms and is likely to play a particularly large role in respect of demonstration effects. Demonstration effects occur as MNCs instil new technologies, management techniques as well as other knowledge into the host country that are observed, copied and adapted by local companies (Altenburg 2000: 13). This indirect effect may evolve from the imitation and translation of ideas from MNC affiliates, but also from local enterprises, which are suppliers to them and have already gained some expertise. It is clear that demonstration effects require a certain degree of knowledge on part of local enterprises, not only to grasp the knowledge and technologies leaking out of MNC operations, but also to respond quickly to new competitive pressures technologically superior enterprises, be they local or foreign, might expose them to.

Another critical way of knowledge infusion into the host economy is embodied in the ‘direct-indirect’ mechanism of training MNC employees coupled with labour turnover. As MNCs often have more advanced equipment, production processes, more up-to-date management techniques and higher quality standards compared to local enterprises, they usually provide some training to host country employees ‘depending on industry, mode of entry, size and time horizon of investment, type of operations, and local conditions’. Moreover, foreign firms’ training programmes often exceed those of their domestic counterparts, particularly in higher level positions, and if MNCs have been operating in the host country over a longer period of time. The knowledge gained by local employees can diffuse within the host economy as they move to other firms or set up their own business. Yet, labour mobility from foreign to local firms is not guaranteed, given that the former generally pay higher wages. In fact, it has been assumed that higher wages serve the purpose of limiting the ‘brain-drain” to local firms (Blomström/ Kokko 1996, 2003; Herkenrath 2003, Javorcik/ Spatareanu 2005). Furthermore, if inter-regional labour mobility is low, knowledge progression may concentrate in only a handful of regions, where foreign affiliates operate and may not reach to the most needy and laggard areas of a country.

Enormous potential for knowledge and technology transfers offer joint venture projects between foreign and local firms, as one sub-form of collaborative linkages. They not only tend to create more linkages with local enterprises (see above), but also allow reciprocal exchange of information facilitating the adaptation of technologies, management and production techniques to host country conditions (for instance culture and climate). They are, however, complicated partnerships that need particularly sensitive treatment. Otherwise, different expectations of the parties involved may lead to insurmountable frictions and the failure of the joint venture.

The preceding elaboration on the social qualities of FDI, narrowed down to its potentials for knowledge and technology spillovers, has given insights into the complexity of issues that would have to be taken into account when mapping out strategies for sustainable host country development in relation to FDI. The bottom-line is that not simply any type of investment activity carried out by a foreign firm leads to an improvement of the knowledge base of a country. Instead, upgrading hinges upon existing capacities in the host country and how well the investment project matches them. Here, it has been suggested that increasing South-South flows might offer new potentials, since ‘their (developing countries’ MNCs) technology may be less advanced, but better suited to the countries in which they invest. They are often closer to the host country, both geographically and culturally, and they tend to be better versed in the risks of investing in a country where the politics is unpredictable and the economy unstable’.

At last, it is useful to bear in mind that knowledge and technology transfers are difficult to measure. MNCs might provide more training hours and more advanced production technologies than do local firms, but as long as they are not integrated and, where necessary, modified according to host country conditions, they will not help the host country to develop in the long run, particularly if MNCs divest before some significant spillovers have taken place.