A Century of Foreign Investment in the Third World

Michael Twomey

• Publisher: Routledge
• Year: 2002
• eBook ISBN: 9781134569205
• Topic: Business
• Subtopic: Business General
• Index: Business

The late twentieth century has witnessed a dramatic upsurge in foreign direct investment in the Third World. Based upon thorough statistical analysis, the book presents exhaustive case-studies of foreign investment policy in 'metropolitan' countries and of the experiences of 'host' countries throughout Africa, Asia and Latin America. With a wide geographical and historical focus, it also makes an important contribution to current debates on dependency theory.

1 Introduction

Major themes

Does foreign direct investment occupy a larger role today in the economies of the Third World than it did at the beginning of the twentieth century? Specifically, do foreigners now own more of the Third World’s productive assets? What can be said about the timing of the expansion of the foreign-owned capital stock in the colonies, and how does that differ by which country was the metropolitan power? How important was the achievement of independence in affecting the amounts of foreign direct investment (hereafter, FDI) in the previously colonial areas? What lies behind the late twentieth-century surge in FDI, and will it last?

These questions motivate the analysis in this book. This a timely investigation, with the current wave of relaxation of restrictions on FDI, the end of the Cold War, and sufficient period having passed since the ending of the colonial era to allow those complex times to be viewed with some perspective. The end of a century invites us to take a longer, more historically informed look at contemporary economic issues such as foreign investment. We push this by attempting a wide geographical coverage— Africa, Asia, and Latin America—one that is simply not present in the historical literature, even if contemporary economic analysis has no qualms about jumping such boundaries. Also revealing the author’s economics background is the decision to begin the analysis before World War I and occasionally before 1900, downplaying the historians’ practice which typically treats the Great War as the definitive watershed.

Our major focus is on foreign direct investment—that which the foreigners control. Nevertheless, the analysis of the experiences of both host countries or source countries requires that we also incorporate data on total foreign investment (hereafter FI), including loans as well as FDI. The analysis of loans to third world countries would inevitably lead us to look at the several debt crises which have been so frequent in the second half of the century. But that is a different story, and so our main interest will be on FDI. The economic framework which informs the organization of the material and the empirical analysis is a mainstream approach deriving from the work of John Dunning and Raymond Vernon. Their insights provide a vision of how FDI affects source and host countries, and what factors produce changes in FDI, in both sets of countries. Our model in comparative, quantitative economic history is Raymond Goldsmith.

It may be useful to place our interests in the context of the major writings on foreign investment. One of the most important approaches to the study of foreign investment has been the measurement of its rate of profit. As will be mentioned below, this had often been part of a broader analysis of the costs and benefits of foreign investment, especially in colonial contexts.

The broad currents of Marxist writings may have influenced some of the questions which are asked here, but they are not present in the formal analysis in the following chapters. Another possibility was to follow the lead of numerous scholars from the Third World, who look to Dependency Theory for conceptual guidelines. A common element of both the Dependency school(s) and the mainstream approach of Dunning, et al. is their association of more FDI with increased impacts in other sectors of the economy. For Dunning this may mean more technology inflows, for many Dependency and Marxist analysts this may imply reduced prospects for growth and development. One book cannot resolve that debate. Our goal is to contribute to the discussion by investigating where FDI has been large or small, in order to orient other studies which perhaps unconsciously assumed an unwarranted conclusion to that essentially empirical question. This study’s data on FDI for the first half century typically come from

This study’s data on FDI for the first half century typically come from sources working in and on the industrial countries. Subsequently, especially after 1970, most of the data comes from the international organizations such as the World Bank and the United Nations, whose sources are the third world countries themselves. There are many problems in working with the available statistics on FDI, which will be acknowledged subsequently. There are some efforts underway at improving the generation of current data. We attempt to build bridges between the better measured data for the contemporary period and that before 1950, when the historical foundations were being established.

One other introductory comment relates to the geographical coverage — the Third World. Canada and Australia are certainly not third world countries, but are included here for purposes of comparison. The received wisdom at the end of the century is that the term Third World has lost much of its usefulness. The term itself was a child of the Cold War, when the First World signified the industrial, capitalist countries, the Second World referred to the socialist countries of the Soviet bloc, and the Third World was everywhere else—with a few countries like Vietnam and Cuba straddling one fence, while others such as South Africa, Israel and certain parts of Europe straddled the other. But the end of the Cold War and the growing differentiation of Third World countries are rending this term obsolete, along with its predecessor, developing countries. For example, Singapore and Saudi Arabia have very high per capita income levels. The newly industrializing countries have a distinct identity in the mind of the general public, as well as of specialists at the World Bank and in academia. We will also note later how countries like Korea, Taiwan, Mexico, Chile and Brazil are fledgling exporters of direct investment. On the plane of international politics, China and India are reasserting themselves as powers in their geographical regions, and beyond. The other side of the coin of increased divergence is the stagnation of several countries, most notably in Africa. Furthermore, the disintegration of the Soviet bloc has increased the number of capital scarce countries with the potential of becoming industrial exporters. We will not propose an alternative classification scheme. The solution of the World Bank, listing countries by income levels, using somewhat arbitrarily defined categories (upper middle income, low income except China and India, and so on) is certainly practical, if not otherwise analytically helpful.

Our intention is to use two twentieth-century terms to describe what may well turn out to have been predominantly a twentieth-century phenomenon. The Third World is indeed a construct of the second half of the century. Moreover, we will also argue that foreign direct investment between the First World and the Third World is also quickly becoming dated, for two reasons. First, this direct investment has resulted primarily because of dramatic differences between first world and third world countries in technological capabilities, or nationalistic governmental policies, an abundance of certain raw materials, or markedly different wage levels. One of the results of this diversification of the Third World is that some of the FDI that these countries receive has come from other third world countries, not just the traditional sources. Furthermore, some third world countries are now exporters of portfolio capital. Secondly, the mode of FDI is evolving. Improved technological and administrative abilities imply that contractual arrangements with the multinational firms no longer cede total control to the latter, in terms of domestic participation in design and production, what products will be produced, and where and how they will be marketed. This does not necessarily imply the elimination of dependency, but it demands that our evaluation of it be updated.

Outline of the book

Chapter 2 begins with a survey of several strands of the major theoretical and empirical works on foreign investment and FDI. The distinction between direct and portfolio investment is introduced, and different related versions of Dunning’s eclectic model, Vernon’s product cycle hypothesis, and Narula’s Investment Development Path are described. Historical work on Free Standing Companies, investment groups and expatriate investment function are then presented, as variations on the central phenomenon of FDI. From this point we investigate aspects of colonialism, and whether or how being a colony might have affected the amount of investment—portfolio or direct—sent to an area. The chapter ends with some observations about measurement issues.

The third chapter provides an overview of global trends in foreign investment during the twentieth century, and then moves to more specific analyses of the countries which were the major sources of capital for the Third World; the United Kingdom, France, the United States, Belgium, the Netherlands and Japan. For some time the sun did not set on the British and French empires, and those countries receive the most attention. The other countries on the list had only one or two formal colonies. Of course the foreign investment of the United States became dominant in the Third World by mid-century. We are cutting corners here, of course, by not including either Germany, Portugal, or other European countries, but the expectation is that we have covered most of the important countries. The two major factors in this chapter are the evolution of the metropolitan countries’ treatment towards their colonies, and the impact of the World Wars and the 1930s Depression.

The next three chapters provide a series of short analyses of the experiences of individual countries of the Third World, and as such form the core material of this book. Comparisons will be made of foreign investment and FDI to local population, GDP, trade and, where possible, the stock of capital. For most countries the population numbers are known well enough for the accuracy required here, and the data on FDI/person basically serve as a check for the other series. Our major innovation is to utilize the results of a significant body of recent research on historical trends of GDP to compare FDI stocks to that variable. The tables in the middle three chapters also include ratios where the denominator is trade —the average of exports and imports—particularly as a substitute for those years where no GDP estimates are available. The shakiness of the data on the capital stock suggests that primary reliance should be placed on trends in the ratio FDI/GDP over time or across countries. Data on the relative size of the stock of foreign investment is also presented, even though our major interest is direct investment. These country studies are grouped geographically; first Africa, then Asia, and finally Latin America. This does not make for a smooth flowing narrative. One alternative selection criteria, sorting by colonial power, only makes sense for the ex-colonies of Britain and France, and not the other three metropolitan countries, and would certainly mix an odd group of countries which during this century were always independent. Moreover, as will be demonstrated, the fact of having been a colony had relatively little to do with the end of century situation with regard to foreign investment.

Chapter 7 attempts to gather up these disparate results and provide some comparative analysis. The topics that are confronted are those of the start of this introductory chapter: who had more or less investment, why did it change, and the impact of colonial status. One theme that is appended is a section on railroads during the first third of the century. Similarly, the end of the century issue of privatization and new forms of FDI are discussed. The chapter ends with a summary of the overall argument, and risks some comments about projections for the future.

Acknowledgments

Over the years I have received helpful comments from several researchers, whom I would like to acknowledge here. Morris Altman, Camron Amin, Ricardo Bielschowsky, Catherine Boone, Victor Bulmer-Thomas, Michael Chege, Ben Gales, Reinaldo Gonçalves, Jean-Francois Hennart, Thomas Lindblad, Angus Maddison, Carlos Marichal, Rory Miller, Michael Monteon, Rajneesh Narula, Irene Norlund, Trithankar Roy, Keetie Sluyterman, Colin Stoneman, William Summerhill, Tom Tomlinson, Steven Topik, Pierre van der Eng, and Mira Wilkins all responded warmly and generously to questions about their own work and the areas that they have studied.

My ideas have been influenced by a conference on Latin American Economic History at Bellagio, Italy, for which I thank its organizers, John Coatsworth and Alan Taylor, the commentator on my paper, Gabriel Tortella, and the other participants, particularly Alan Dye, Anne Hanley, Nanno Mulder, and Gail Triner. Special thanks to André Hofman and Lance Davis, who generously shared not only their insights but also important and unpublished data.

Dedication

Many of us who lived during more than half of the twentieth century are still having difficulty assimilating the impact of all the dramatic events that occurred during it. A less dramatic, but more personal recognition of the passage of time is the realization that I began my professional career more than three decades ago, teaching economics at the Catholic University in Lima, Peru. At many times while working on this book I reached back for support and inspiration to the memories of personal cordiality and high professional standards for intellectual freedom in academic research that were espoused and maintained by my colleagues there, of whom I especially remember Máximo Vega-Centeno, Adolfo Figueroa, Rufino Cebrecos, Ivan Rivera, as well as José María Caballero, Michel Delbuono, and Juan Antonio Morales. These fond recollections were warmly revived during a most welcome stay in Michigan by my ex-officemate Guillermo Rochabrún together with his wife Teresa Oré and their son Marcelo. To all of them and with best wishes for the continuing success of their work, I dedicate this book.

2 Conceptualizing and measuring foreign investment

This chapter reviews several models of foreign investment, beginning with very basic textbook models, and subsequently incorporating newer versions which are refined to incorporate specific historical cases or contemporary phenomena. The theoretical discussion leads to various comments about measurement issues, relating to foreign investment and the national economic aggregates to which it is compared. These questions are broadly described here and then addressed in subsequent chapters of the book.

Theoretical perspectives

The simplest and probably the earliest model explaining foreign capital flows claims that they are a function of the return to capital—interest rates. In this story, capital flows respond to interest rate differentials, continuing until these are eliminated. Typically, the wealthier country has lower interest rates, because of its abundance of capital and loanable funds. In a simple before-and-after scenario, interest rate differentials exist because of controls in capital markets, and relaxation of those controls leads to capital flows— foreign investment. Slightly more complex versions, building off the same basic principles, implicitly speak of potential interest rate differentials arising because of different rates of saving and investing in the several countries. A standard example is the belief that “young” countries at the beginning of the twentieth century had insufficient savings compared to their investment opportunities, and therefore turned to the “old world” for savings, which materialized as foreign investment. A recent treatment along these lines is Taylor and Williamson (1994).

One reason for creating theoretical models is to generate predictions of the effects of economic processes. Thus, as a standard textbook exercise, foreign capital flows which result from interest rate differentials will raise income in the receiving, or host country, and lower domestic income in the sending, or source country (Salvatore 1998:375). In addition, the distribution of income will be affected. Wages and/or employment will rise in the receiving, or host country, while the return to capital will fall there, with the opposite effects occurring in the sending country. World income and efficiency will both rise. Such a prediction jars with the received wisdom of most writing on third world areas—particularly historical work, not to mention literature in the Marxist traditions. The mathematical rigor of the model does not hide the fact that, as a description of concrete reality, it is terribly simplistic. That observation is different from saying that the model is wrong; the theorist’s task is to simplify down to the key factors in a given situation.¹ The theoretical models can be made indefinitely more complex, starting off with allowing for repatriation of the earnings of the foreign investment, through conversion of loans into consumption, side effects on exchange rates, and by explicitly giving the analysis an inter-temporal dimension. Even though such extensions inevitably multiply the range of possible outcomes to the theoretical exercise of the impact of foreign investment, the standard vision of international economists remains that such investment is beneficial to the recipient country.

The next level of sophistication categorizes capital flows as direct or portfolio. Direct investment is associated with control, usually identified empirically by having achieved ownership of a certain fraction of the outstanding equity of a company, such as 10 or 25 per cent. In contrast, portfolio investment involves loans at fixed rates of interest, most often to governmental entities, and provides no managerial control. There is a strong tradition in British economic history to identify a presumed preference for portfolio finance as a symptom of an aversion toward risk and a general lack of entrepreneurship.

The distinction between portfolio and direct investment only gained wide acceptance after World War II, when international capital markets were dominated by investments from the United States, whose overseas capital flows were indeed measured according to that conceptual scheme. Nevertheless, the identification of control with ownership of equity, and not with portfolio lending, is often questionable even in the British case, as discussed by Edelstein (1982:33–7). Further confusion arises because at the beginning of the twentieth century the term direct investment was applied to funds that firms raised outside of financial markets, typically “directly” through reinvestment of profits, or perhaps through financing by immigrants. The early investigators who based their estimates of foreign investment on data from the financial markets would not have possessed concrete information on direct investment as it was then understood, and often relied on asserting the equivalent of “everyone knows” that it was small.²

Several examples from the end of the twentieth century could be mentioned of situations for which the portfolio/direct dichotomy is inadequate. Lending agencies, such as commercial banks or the International Monetary Fund, continually exercise a degree of control by means of a potential threat not to extend credit to a firm—or national government— which engages in undesirable actions. Recent changes in international capital markets have facilitated transactions in the stock of companies using another country’s currency, generating what is termed foreign equity flows. The growth of franchising, particularly in services such as hotels or fast food chains, does not necessarily involve capital flows, but certainly produces very visible symptoms of a foreign presence.

Furthermore, the distinction between portfolio and direct does not lend itself easily to empirical studies explaining why one mode was chosen over the other. Now, it was the case that most foreign investments by US businesses involved direct ownership of assets overseas, and US portfolio investment was sent to governments, so the particular question of choice of mode of investment received little attention. In particular, it took some time for researchers to suggest factors besides interest rates, or less aversion to risk, that migh...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Tables
• Graphs
• List of Abbreviations and Currencies
• 1: Introduction
• 2: Conceptualizing and Measuring Foreign Investment
• 3: The Major Source Countries
• 4: Africa
• 5: Asia and the Middle East
• 6: Latin America, the Caribbean, and Canada
• 7: General Results
• Bibliography