Therefore, if they are genuinely to help developing countries develop through trade, wealthy countries need to accept asymmetric protectionism, as they used to between the 1950s and the 1970s. They should acknowledge that they need to have much lower protection for themselves than the developing countries have. The global trading system should support the developmental efforts of developing countries by allowing them to use more freely the tools of infant industry promotion – such as tariff protection, subsidies and foreign investment regulation. At the moment, the system allows protection and subsidies much more readily in areas where the developed countries need them. But it should be the other way around – protection and subsidies should be easier to use where the developing countries need them more.
Here, it is particularly important to get our perspective right about agricultural liberalization in the rich countries. Lowering agricultural protection in those countries may help some developing countries, especially Brazil and Argentina, but not most. Above all, agricultural liberalization in the rich world should not be conditional upon further restrictions on the use of the tools of infant industry promotion by developing nations, as is currently being demanded by the rich countries.
The importance of international trade for economic development cannot be overemphasized. But free trade is not the best path to economic development.Trade helps economic development only when the country employs a mixture of protection and open trade, constantly adjusting it according to its changing needs and capabilities. Trade is simply too important for economic development to be left to free trade economists.
CHAPTER 4
The Finn and the elephant
The Finns like to tell a joke about themselves. What would a German, a Frenchman, an American and a Finn do if they were each asked to write a book on the elephant? The German, with his characteristic thoroughness, would write a thick two-volume, fully annotated study entitled, Everything That There is to Know About the Elephant. The Frenchman, with his penchant for philosophical musings and existential anguish, would write a book entitled The Life and Philosophy of the Elephant. The American, with his famous nose for good business opportunities, would naturally write a book entitled, How to Make Money with an Elephant. The Finn would write a book entitled What Does the Elephant Think of the Finns?
The Finns are laughing at their excessive self-consciousness. Their preoccupation with their own identity is understandable. They speak a language that is more related to Korean and Japanese than to the language of their Swedish or Russian neighbours. Finland was a Swedish colony for around six hundred years and a Russian colony for about a hundred. As a Korean, whose country has been pushed around for thousands of years by every neighbour in sight – the Chinese, the Huns, the Mongolians, the Manchurians, the Japanese, the Americans, the Russians, you name it – I know the feeling.
So, it was unsurprising that, after gaining independence from Russia in 1918, Finland tried its best to keep foreigners out. The country introduced a series of laws in the 1930s that officially classified all the enterprises with more than 20% foreign ownership as – hold your breath – ‘dangerous’. The Finns may not be the subtlest people in the world, but this is heavy stuff even for them. Finland got, as it had wanted, very little foreign investment.[1] When Monty Python sang in 1980, ‘Finland, Finland, Finland … You are so sadly neglected, and often ignored’ (‘The Finland Song’), they did not perhaps guess that the Finns had sought to be neglected and ignored.
The Finnish law was eventually relaxed in 1987, and the foreign ownership ceiling was raised to 40%, but all foreign investments still had to be approved by the Ministry of Trade and Industry. General liberalization of foreign investment did not come until 1993, as part of the preparations for the country’s accession to the EU in 1995.
According to the neo-liberal orthodoxy, this sort of extreme anti-foreign strategy, especially if sustained for over half a century, should have severely damaged Finland’s economic prospects. However, since the mid-1990s, Finland has been touted as the paragon of successful global integration. In particular, Nokia, its mobile phone company, has been, figuratively speaking, inducted into the Globalization Hall of Fame. A country that did not want to be a part of the global economy has suddenly become an icon of globalization. How was this possible? We shall answer that later, but first let us examine the arguments for and against foreign investment.
Many developing countries find it difficult to generate enough savings to satisfy their own investment demands. Given this, it seems uncontroversial that any additional money they can get from other countries that have surplus savings should be good. Developing countries should open their capital markets, it is argued by the Bad Samaritans, so that such money can flow in freely.
The benefit of having free international movement of capital, neo-liberal economists argue, does not stop at plugging such a ‘savings gap’. It improves economic efficiency by allowing capital to flow into projects with the highest possible returns on a global scale. Free cross-border capital flows are also seen as spreading ‘best practice’ in government policy and corporate governance. Foreign investors would simply pull out, the reasoning goes, if companies and countries were not well run.[2] Some even, controversially, argue that these ‘collateral benefits’ are even more important than the direct benefits that come from the more efficient allocation of capital.[3]
Foreign capital flows into developing countries consist of three main elements – grants, debts and investments. Grants are money given away (but often with strings attached) by another country and are called foreign aid or official development assistance (ODA). Debts consist of bank loans and bonds (government bonds and corporate bonds).[4] Investments are made up of ‘portfolio equity investment’, which is equity (share) ownership seeking financial returns rather than managerial influence, and foreign direct investment (FDI), which involves the purchase of equity with a view to influence the management of the firm on a regular basis.[5]
There is an increasingly popular view among neo-liberal economists that foreign aid does not work, although others argue that the ‘right’ kind of aid (that is, aid that is not primarily motivated by geo-politics) works.[6] Debts and portfolio equity investment have also come under attack for their volatility.[7] Bank loans are notoriously volatile. For example, in 1998, total net bank loans to developing countries were $50 billion; following a series of financial crises that engulfed the developing world (Asia in 1997, Russia and Brazil in 1998, Argentina in 2002), they turned negative for the next four years (-$6.5 billion per year on average); by 2005, however, they were 30% higher than in 1998 ($67 billion). Although not as volatile as bank loans, capital inflows through bonds fluctuate a lot.[8] Portfolio equity investment is even more volatile than bonds, although not as volatile as bank loans.[9]
1
Between 1971 and 1985, FDI accounted for only about 0.6% of total fixed capital formation (physical investment) of Finland. Outside the communist bloc, only Japan, at 0.1%, had a lower ratio. The data are from UNCTAD (various years),
2
M. Feldstein (2000), ‘Aspects of Global Economic Integration: Outlook for the Future’, NBER Working Paper, no. 7899, National Bureau of Economic Research, Cambridge, Massachusetts.
3
A. Kose, E. Prasad, K. Rogeff & S-J. Wei (2006), ‘Financial Globalisation: A Reappraisal’, IMFWorking Paper, WP/06/189, International Monetary Fund (IMF), Washington, DC.
4
Bank loans used to be the dominant element of debts until recently, but now bonds account for the lion’s share. Between 1975 and 1982, bonds accounted for only about 5% of total net private debts contracted by developing countries. The share rose to about 30% between 1990 and 1998, and to nearly 70% between 1999 and 2005. The data are from World Bank,
5
The distinction between portfolio equity investment and FDI is, in practice, ambiguous. FDI is usually defined as an investor buying up more than a 10% stake in a company in a foreign country, with the intention of getting involved in the management of the company. But there is no economic theory that says that the threshold should be 10%. Moreover, there is a hybrid form emerging that blurs the boundary even more. Traditionally, foreign direct investment has been made by transnational corporations (TNCs), which are defined as productive corporations with operations in more than one country. But recently what the UN calls ‘collective investment funds’ (such as private equity funds, mutual funds or hedge funds) have become active in foreign direct investment. FDI by these funds differs from traditional FDI by TNCs because it does not have the potentially infinite commitments of TNCs. These funds typically buy up firms with a view to selling them off after 5–10 years, or even earlier – without improving their productive capabilities, if they can get away with it. On this phenomenon, see UNCTAD (2006),
6
For an up-to-date literature review on the aid issue, see S. Reddy & C. Minoiu (2006), ‘Development Aid and Economic Growth: A Positive Long-Run Relation’, DESA Working Paper, no. 29, September 2006, Department of Economic and Social Affairs (DESA), United Nations, New York.
7
The data on capital flows in this paragraph are from World Bank (2006),
8
Foreigners bought $38 billion worth of developing country bonds in 1997, but, during 1998–2002, the sum fell to $23 billion per year.During 2003–2005, the amount went up to $44 billion per year. This means that, compared to 1997, bond purchases during 1998–2002 was 40% lower, while the 2003–5 purchase was double that of the ‘dry’ period and 15% higher than in 1997.
9
Portfolio equity investment into developing countries fell from $31 billion in 1997 to $9 billion per year during 1998–2002. In 2003–5, it averaged $41 billion per year. This means that, during 1998–2002, the average annual portfolio equity investment inflow into developing countries was less than 30% of what it was in 1997. In 2003–5, it was 30% higher than in 1997 and 4. 5 times more than in the ‘dry’ period of 1998–2002.