First of all, we need to remember that a lot of foreign investment is what is known as ‘brownfield investment,’ that is, acquisition of existing firms by a foreign firm, rather than ‘greenfield investment’, which involves a foreign firm setting up new production facilities. Since the 1990s, brownfield investment has accounted for over half of total world foreign direct investment (FDI), even reaching 80 per cent in 2001, at the height of the international mergers and acquisitions (M&A) boom. This means that the majority of FDI involves taking control of existing firms, rather than the creation of new output and jobs. Of course, the new owners may inject better managerial and technological capabilities and revive an ailing company – as seen in the case of Nissan under Carlos Ghosn – but very often such an acquisition is made with a view to utilizing capabilities that already exist in the acquired company rather than creating new ones. And, more importantly, once your national firm is acquired by a foreign firm, the home bias of the acquiring company will in the long run impose a ceiling on how far it progresses in the internal pecking order of the acquiring company.
Even in the case of greenfield investment, home-country bias is a factor to consider. Yes, greenfield investment creates new productive capabilities, so it is by definition better than the alternative, that is, no investment. However, the question that policy-makers need to consider before accepting it is how it is going to affect the future trajectory of their national economy. Different activities have different potentials for technological innovation and productivity growth, and therefore what you do today influences what you will be doing in the future and what you will get out of it. As a popular saying among American industrial policy experts in the 1980s went, we cannot pretend that it does not matter whether you produce potato chips, wood chips or microchips. And the chance is that a foreign company is more likely to produce potato chips or wood chips than microchips in your country.
Given this, especially for a developing country, whose national firms are still underdeveloped, it may be better to restrict FDI at least in some industries and try to raise national firms so that they become credible alternative investors to foreign companies. This will make the country lose some investment in the short run, but it may enable it to have more higher-end activities within its borders in the long run. Or, even better, the developing country government can allow foreign investment under conditions that will help the country upgrade the capabilities of national firms faster – for example, by requiring joint ventures (which will promote the transfer of managerial techniques), demanding more active technology transfer, or mandating worker training.
Now, saying that foreign capital is likely to be less good for your country than your own national capital is not to say that we should always prefer national capital to foreign capital. This is because its nationality is not the only thing that determines the behaviour of capital. The intention and the capability of the capital in question also matter.
Suppose that you are thinking of selling a struggling nationally owned car company. Ideally, you want the new owner to have the willingness and the ability to upgrade the company in the long run. The prospective buyer is more likely to have the technological capabilities to do so when it is an already established automobile producer, whether national or foreign, rather than when it is finance capital, such as a private equity fund.
In recent years, private equity funds have played an increasingly important role in corporate acquisitions. Even though they have no in-house expertise in particular industries, they may, in theory, acquire a company for the long term and hire industry experts as managers and ask them to upgrade its capabilities. However, in practice, these funds usually have no intention to upgrade the acquired company for the long term. They acquire firms with a view to selling them on in three to five years after restructuring them into profitability. Such restructuring, given the time horizon, usually involves cutting costs (especially sacking workers and refraining from long-term investments), rather than raising capabilities. Such restructuring is likely to hurt the long-term prospects of the company by weakening its ability to generate productivity growth. In the worst cases, private equity funds may acquire companies with the explicit intention to engage in asset-stripping, selling the valuable assets of a company without regard to its long-term future. What the now-notorious Phoenix Venture Holdings did to the British car-maker Rover, which they had bought from BMW, is a classic example of this (the so-called ‘Phoenix Four’ became particularly notorious for paying themselves huge salaries and their friends exorbitant consultancy fees).
Of course, this is not to say that firms that are already operating in the industry will always have the intention to upgrade the acquired company for the long term either. When GM acquired a series of smaller foreign car companies – such as Sweden’s Saab and Korea’s Daewoo – during the decade before its bankruptcy in 2009, the intention was to live off the technologies accumulated by these companies, rather than to upgrade them (see Thing 18). Moreover, recently the distinction between industrial capital and finance capital has come to be blurred, with industrial companies such as GM and GE making more profits in finance than in industry (see Thing 22), so the fact that the acquiring firm operates in a particular industry is not a guarantee of a long-term commitment to that industry.
So, if a foreign company operating in the same industry is buying up your national company with a serious long-term commitment, selling it to that company may be better than selling it to your own national private equity fund. However, other things being equal, the chance is that your national company is going to act in a way that is more favourable to your national economy.
Thus, despite the globalization rhetoric, the nationality of a firm is still a key to deciding where its high-grade activities, such as R&D and strategizing, are going to be located. Nationality is not the only determinant of firm behaviour, so we need to take into account other factors, such as whether the investor has a track record in the industry concerned and how strong its long-term commitment to the acquired company really is. While a blind rejection of foreign capital is wrong, it would be very naïve to design economic policies on the myth that capital does not have national roots any more. After all, Lord Mandelson’s belatedly found reservations turn out to have a serious basis in reality.
Thing 9
We do not live in a post-industrial age
Our economy has been fundamentally transformed during the last few decades. Especially in the rich countries, manufacturing industry, once the driving force of capitalism, is not important any more. With the natural tendency for the (relative) demand for services to rise with prosperity and with the rise of high-productivity knowledge-based services (such as banking and management consulting), manufacturing industries have gone into decline in all rich countries. These countries have entered the ‘post-industrial’ age, where most people work in services and most outputs are services. The decline of manufacturing is not only something natural that we needn’t worry about but something that we should really celebrate. With the rise of knowledge-based services, it may be better even for some developing countries to skip those doomed manufacturing activities altogether and leapfrog straight to a service-based post-industrial economy.
We may be living in a post-industrial society in the sense that most of us work in shops and offices rather than in factories. But we have not entered a post-industrial stage of development in the sense that industry has become unimportant. Most (although not all) of the shrinkage in the share of manufacturing in total output is not due to the fall in the absolute quantity of manufactured goods produced but due to the fall in their prices relative to those for services, which is caused by their faster growth in productivity (output per unit of input). Now, even though de-industrialization is mainly due to this differential productivity growth across sectors, and thus may not be something negative in itself, it has negative consequences for economy-wide productivity growth and for the balance of payments, which cannot be ignored. As for the idea that developing countries can largely skip industrialization and enter the post-industrial phase directly, it is a fantasy. Their limited scope for productivity growth makes services a poor engine of growth. The low tradability of services means that a more service-based economy will have a lower ability to export. Lower export earnings means a weaker ability to buy advanced technologies from abroad, which in turn leads to a slower growth.