It is hardly debatable that FDI is instrumental in the modernizing and industrializing endeavors of late developers. Newly industrializing countries need FDI for capital, which their young domestic economies simply cannot provide enough however high the savings rate; for technology and managerial skills, which they severely lack after years of backwardness; and for foreign market penetration, which would be otherwise impossible for neophytes with low-tech products and little business connections.
It is dangerously convenient enough to go from there to the conclusion that FDI is always and inherently the driving force of economic development (note how that assertion actually sounds commonplace and sensible.) This statement makes a fallacious jump by overlooking three things: 1) the interest of foreign investors is not developmental in its nature (but profit-making), 2) not every FDI and its accompanying business model entails the same spillover effects (e.g. technology and managerial skills diffusion, cultivation of local suppliers, etc.) and 3) a development that relies exclusively on capital accumulation is inefficient and ultimately unsustainable. These theoretically erroneous assumptions lead to concrete and severe mistakes in policies that equate a quantitative increase of FDI with economic development.
Besides a lack of technical knowledge, political expediency certainly encourages this kind of calculated naïveté, since politicians always need a clean, simple measurement to beguile the public and maintain their legitimacy. A too effective propaganda, a too well constructed alternative reality then often takes revenge upon its own creator in a viral process of deception and self-deception, which results in a saturating misunderstanding of FDI.
The stated theoretical issues and their real entailing problems are not new; they have persisted along with the existence of FDI. For example, there has always been a competition between governments (state vs. state, local vs. local) for FDI, and therefore, a bargain leverage for investors. This is due to two reasons: 1) labor and facilities are less mobile than capital (i.e. investors can easily switch to wherever offers most benefits) and 2) FDI is a limited resource.
But what is new is that globalization has exacerbated this problem so much it has been dubbed “the race to the bottom.” In competing for FDI, governments have to keep lowering their gain, relaxing labor laws, and giving investors more autonomy, etc. They have increasingly little say on their own fate. This weakening position of governments and labors are due to several factors particular to this era.
One, with financial innovation, capital is now more mobile than ever. Large amount of capital can move with such incredible speed. Against the backdrop of much stickier institutional change and of necessarily limited human processing capacity, this increase in capital fluidity is no longer quantitative. Foreign investors now have a new, qualitatively different leverage in bargaining with governments.
Two, late developers need much more capital than their predecessors. Facing an ever widening technological and infrastructural gap, and an established division of labor, developing countries have a huge start up cost, which they simply cannot finance on their own. This problem is rather intuitive and by no means new. Even in the early days of capitalism, while British industrial revolution could be financed simply by individual, medium-scaled factories, Germany and France, the “late developers”, needed a wholly new kind of heavily capitalized, long-term minded investment bank to support their industrializing attempt.
Historical contingencies also contribute to today developers’ heavy reliance on FDI. The ending of the Cold War marks the ending of the U.S. financial assistance and trade-deficit tolerance reserved for its allies (South Korea, Japan, Taiwan). Freed from its developmental responsibility, the U.S. now aggressively demands financial and trade liberalization through the World Bank and the IMF. This leaves developing countries further susceptible to FDI, since the states can no longer restrict the forms or amounts of foreign investments.
Three, decentralization, an accompanying aspect of modernization, has induced a fiercer competition between local governments. Decentralization has done precisely what it has been designed for: making local states more self-reliant, more self-aware, and more self-interested. But besides the positive effect of greater efficiency, this new entrepreneurial nature of local states inadvertently turns them into Game Theory players in a destructive race to attract capital.
Four, the emerging political economy of China particularly crave for FDI. The developmental mission of China is quite convoluted: it wants a developed economy, but resists a growing private sector, which poses potential threat to the ruling power. Therefore, China has ingenuously used FDI as a replacement of domestic businesses: it is an economic development without a cultivation of national entrepreneurs. Due to its political cause, China’s massive demand for FDI is not likely to subside, making the shortage of FDI more intense and foreign investors more powerful.
How much of these theories have been translated into real change in the dynamics between states and FDI? There is substantial literature that deals with competition between ASEAN and China, and between Chinese local states, which confirms waves after waves of liberalization, in terms of relaxation of labor law, domestic content requirements, etc. Quite counterintuitively, FDI has often brought worse working conditions and minimal spillover effect on domestic economies of today developers.
I am quite interested in how this darker side of FDI plays out in Vietnam political economy. Part of the reason is that researches on FDI in Vietnam that I’ve read so far almost solely use technical statistics or economic equations to confirm the effects of FDI without understanding at all its causes or dynamics. I’ll reserve my rant on how naïve this politically insulated approach is in the case of a country such as Vietnam for another time.