Multinational enterprises in asian development

Saving, Investment and Growth in India [with Kunal Sen] 2003Crisis and Recovery in Malaysia: The Role of Capital Controls 2003 Growth, Employment and Migration in Mainland Southeast Asia

Development

Saving, Investment and Growth in India [with Kunal Sen] (2003)

Crisis and Recovery in Malaysia: The Role of Capital Controls (2003) Growth, Employment and Migration in Mainland Southeast Asia:

Structural Change in the Greater Mekong Economies [with Chris Manning

and Piyasiri Wickramasekara] (2000)

Liberalization and Industrial Transformation: Sri Lanka in International Perspective [with Sarath Rajapatirana] (2000)

Structural Change and International Migration in East Asia: Adjusting to Labour Scarcity [with Chris Manning] (1999)

Trade Policy Issues in Asian Development (1998)

Macroeconomic Policies, Crises and Growth in Sri Lanka, 1969–1990 [with

Enterprises in Asian Development

All rights reserved No part of this publication may be reproduced, stored in

a retrieval system or transmitted in any form or by any means, electronic,

mechanical or photocopying, recording, or otherwise without the prior

permission of the publisher.

Edward Elgar Publishing, Inc.

William Pratt House

9 Dewey Court

Northampton

Massachusetts 01060

USA

A catalogue record for this book

is available from the British Library

Library of Congress Cataloguing in Publication Data

Athukorala, Prema-chandra

Multinational enterprises in Asian development / Prema-chandra

Athukorala.

p cm.

Includes bibliographical references and index.

1 International business enterprises—Asia 2 Asia—Economic policy.

Max Corden

The role of MNEs in economic development: changing

vii

6 Capital inflows and the real exchange rate: foreign direct

Appendix 7.1: Measurement of total factor productivity

ix

developing Asian countries: MNE share in total

manufactured exports and selected export

x

5.5 Asian crisis countries: foreign direct investment as a

percentage of total host-country exports in

with trade orientation measured by Sachs–Warner index

stock, sales, R&D expenditure and R&D–sales

8.A3 Determinants of R&D intensity: alternative

9.1 Envisaged investment and employment in firms

Both scholarly and policy interest in the role of multinational enterprises(MNEs) in the contemporary world economy has burgeoned in recentyears against a backdrop of growing economic integration of nationaleconomies into the global economic system The data chronicling their

litera-ture, both theoretical and empirical, dissecting their activities has grownmuch richer However, the implications of the operations of MNEs for eco-nomic development in host developing countries remain elusive There aremany unresolved issues relating to designing policies to regulate andmonitor the entry and operations of MNEs as part of the overall national

examining some issues central to this policy debate in the light of the riences of developing countries in Asia Developing Asia provides a valu-able laboratory for the study of these issues, given the long-standingpresence of MNEs in many of these countries and the diversity amongcountries in terms of the stage of development and the timing of policytransition towards greater receptivity to MNE involvement in the nationaleconomies

expe-The book begins with an overview chapter which traces the evolution ofpost-war thinking and paradigm shifts relating to the role of MNEs andforeign direct investment in economic development and describes the struc-ture and contents of the ensuing chapters The next chapter gives a broad-brush picture of policy reforms and the investment climate in developingAsian economies and examines, from a comparative regional and global

struc-tured thematically, with each chapter providing a self-contained treatment

of a selected theme of the contemporary debate on harnessing MNE ticipation in national development The issues covered in the chaptersinclude the role of MNEs in manufacturing export expansion; the ongoingprocess of international product fragmentation and its implications fortrade patterns and global integration of developing countries; globalresearch and development activities of MNEs; the relative stability of

xiii

operations of multinational enterprises for the recovery process; the cations of MNE presence for productivity growth in manufacturing, and therole of host country trade policy in conditioning the outcome; and the role

impli-of foreign direct investment in economic transition in former centrallyplanned economies (based on the experience of Vietnam) The core (the-matic) chapters follow a common structure encompassing the state of thedebate, relevant theory, methodology and data sources, and policy implica-tions of the results, with extensive referencing to the related literature forthose desiring to pursue the individual topics further Two key concerns thatguide the empirical analysis throughout are the interconnection betweentheory and practice and the choice of analytical procedures and tools with

a view to getting the maximum out of the available (limited) data

I believe that the book will be of interest to a broad audience, consisting

of students, professional economists and policy makers The economics ofMNEs is a popular subject in advanced undergraduate (college) and grad-uate curricula, in its own right or as a major component of courses in inter-national economics, development economics and international business.While there are a number of excellent textbooks on the subject, there is adearth of empirical evidence and case study material to supplement the

the book will also serve as a valuable reference source for professional omists, and policy makers in developing countries and international devel-opment agencies in broadening their understanding of the role of MNEs

econ-as an integral part of the international dimensions of development policy

policy-oriented books in this area, not only in terms of the subject

unexploited data sources in studying the issues at hand

Chapters 4, 5, 6, 7 and 9 draw upon my sole or joint contributions to the

following journals: Asian Economic Papers (MIT Press); the Australian Economic History Review (Blackwell); The World Economy (Blackwell); Transnational Corporations (United Nations); and the Oxford Bulletin of Economics and Statistics (Blackwell) I thank the publishers for granting

copyright clearance The published material is incorporated in the book

overlap as well as to update the data and the literature coverage

It is a pleasure to thank everyone who helped me in this endeavour Mostimportantly, I am grateful to my co-authors, Sarath Rajapatirana, SatishChand and Sisira Jayasuriya, both for fruitful research collaboration overthe years and for permission to make use of material from our joint papers

in Chapters 6, 7 and 9 respectively I would also like to express profoundgratitude to Peter Drysdale, Chris Findley, Ross Garnaut, Hal Hill, Vijay

Joshi, Chris Manning, Ross McLeod, Xin Meng, Kunal Sen and PeterWarr for valuable comments on and constructive criticism of variousversions of one or more of the individual chapters A special vote of thanksgoes to Max Corden, James Riedel and Tony Thirlwall, and also to SarathRajapatirana for valuable advice and encouragement over many years.

PhD students, Juthathip Jongwanich, Archanun Kohpaiboon, NobuakiYamashita and Tran Quang Tien, who always performed beyond the call

of duty To them, I express my profound appreciation Edward ElgarPublishing Ltd has been unfailingly helpful; I am indebted to Edward Elgarfor nudging me into this project, and to Alexandra O’Connell, Suzanne

into a beautiful book

Finally, my family – Soma, Chintana and Chaturica – deserve mywarmest thanks for love, forbearance and unwavering support withoutwhich this task would never have been completed Chintana and Chaturicaalso deserve thanks for help with preparing the manuscript

Chandra AthukoralaAustralian National University

June 2006

1 Multinational enterprises and

developing countries: background and preview

process of economic globalization which is encapsulating and figuring the nature of global economic space By the early 1970s, manyUS-based enterprises had already gone some way toward creating a global

high-income developing countries, in particular the East Asian newlyindustrializing countries, was an even more recent phenomenon, dating

firms head-quartered in many different countries Activities of MNEs haveexpanded from mining and petroleum industries, the traditional mainstay

of their global operations, to manufacturing and services They have lished a strong and ever increasing presence in almost every country, includ-ing the former centrally planned economies in Asia and Central andEastern Europe, linking factor and product markets across the globe.Global operations of MNEs are therefore a key factor that impinges onthe designing of national development policy in the context of a rapidlyglobalizing world economy

indicator of the scale of MNE activity – grew dramatically from an averageannual level of US$59 billion during 1980–84 to US$844 billion during2000–04, recording an annual compound growth rate of about 5 per cent

to 32 per cent between these time points The bulk of total world FDI

countries (including transition economies) hovering around an average

capital formation in developing countries compared with developed tries (8.5 per cent and 4.4 per cent respectively during 1980–2004)

coun-1

Moreover, from about the late 1980s, FDI has continued to be the largest

development assistance (ODA)) for developing countries During 2000–04,

The scale of MNE activity is obviously better gauged by direct indicators

of their performance, such as production, sales or employment, rather than

national boundaries (Lipsey 2004) According to available rough estimates(made by extrapolating the available data to the global level), production in

the country of residence of their parent companies) increased persistentlyfrom about 4 per cent of world output (GDP) in 1982 to about 10 per cent

in 2004, and their share in world merchandise trade rose from 32 per cent

increase (from 19.6 million to 57.4 million) between 1982 and 2003(UNCTAD 2005, Table 1.3)

Data on FDI (or direct performance indicators) tell only part of the story

‘the modern multinational company is primarily a vehicle for the transfer

the form of technology, managerial expertise, marketing know-how and

the market by the host country As part of the parent company’s globalnetwork, they also have marketing channels in place and possess experienceand expertise in product development and international marketing Given

contribute directly to the economic growth of the host country through

firms On the positive side, foreign firms can act as conduits of new

procuring material inputs and services Technology diffusion may occurthrough labour turnover as domestic employees move from foreign to

their business prowess to thwart domestic entrepreneurial initiativesthrough ‘unfair’ competition They could attract scarce trained domestic

pro-viding better working conductions (Caves 1996, Barba Navaretti andVenables 2004, Blomström and Kokko 1998)

A given degree of MNE presence as usually measured by FDI relative tothe size of the economy is, however, unlikely to have the same impact oneconomic performance in all host countries There is ample theoreticalreasoning backed by empirical evidence that the national gains from MNEpresence are conditioned by the nature of the domestic policy regime andvarious resource-endowment related factors such as the stage of human

policy regime, a country with an outward-oriented policy regime has the

policy bias in favour of import-substitution production This is because, incontrast to an import-substitution regime, an export-oriented regimegenerally encourages MNE activities where the host country has compar-

presence may also depend on the host country’s policies impacting on theperformance of domestic private enterprises A policy regime whichdiscriminates against domestic entrepreneurial initiatives in favour of state-

host country which is at an advanced stage of human capital and neurial development is better placed to reap technological spillovers fromMNE presence than a country with a lower ranking in terms of these pre-

firms to invest in skill development and research and development (R&D)activities

THE ROLE OF MNES IN ECONOMIC

DEVELOPMENT: CHANGING PERCEPTIONS

consensus in the economic profession that FDI (or private foreign

more to help as far as economic and social overheads were concerned, but

PFI was more appropriate in mining and manufacturing, areas inwhich governments had little or no expertise In these areas, PFI wasregarded as the largest potential source of capital and other complemen-tary resources – entrepreneurship, technology, management and market-ing – lacking in developing countries Thus the policy advocacy of thetime encouraged developing countries to provide a hospitable climatefor foreign investment, not only through removing/reducing regulatorybarriers but often through such policy inducements as tax holidays andsubsidies (Little 1982, Chapter 8).

This receptive attitude towards FDI was rather short lived, however.From about the early 1960s the relationship between the MNEs and thenational state became increasingly hostile against the backdrop of the wave

of independence movements and the struggle for social and economictransformation in the new nations emerging from the colonial era The gov-ernments of developing countries began to be increasingly concerned with

perception was partly based on various highly published cases of ‘ruthless’exploitation of natural resources by MNEs and the unacceptable interven-

1977, 2000)

There also emerged a growing scepticism in the economic profession ofthe day about the impact of FDI, with an increasing number of economistsportraying foreign direct investment as basically an exploitative relation-ship which set developing countries on a dead-end route of ‘dependentcapitalism’ In line with the basic thrust of development thinking of theday, which considered the external resource gap as the prime constraint on

began to be dominated by the fear that MNEs might worsen countries’balance of payments A series of studies commissioned by UNCTAD on

published in Lall and Streeten 1977) forcefully argued that MNEs tribute to a worsening balance of payments position of host countries

investment from funds raised locally rather than through actual directforeign investment, while not generating enough foreign exchange earnings

studies, which spawned a series of supporting studies by various individual

approach to foreign investment approval and monitoring of the activities

performance requirements and restrictions on profit remittances, andsetting up of institutional mechanisms for monitoring pricing practices.Another school of thought that held sway (particularly in LatinAmerica) during this period argued that FDI helps to create local initiatives

in the early stages of development but later discourages them by ing local technological development and growth of indigenous enterprises(Hirschman 1969) The real national development challenge for host coun-tries to MNEs, according to this view, was ‘how to divest [not how topromote] FDI’ The hostile attitude towards MNEs based on these polit-ical and economic considerations triggered a wave of nationalizations of

particular, responded to these nationalizations with various retaliatoryactions, compounding the initial host-country suspicion of MNEs asinstruments of imperialism The cumulative outcome was a massive con-traction in foreign investment in many countries in the 1960s and 1970s(Vernon 2000, pp 67–70)

From about the late 1970s, the interaction between the developing tries and MNEs gradually shifted from being largely adversarial andconfrontational to being conciliatory and cooperative Several factorsaccounted for this change in attitude First, a growing body of scholarlyresearch served to tone down the strongest of the criticisms of MNEs indeveloping countries In particular, the new evidence served to demonstrate

as partners, rather than protagonists, in the national wealth-creation process

both foreign-owned and domestic enterprises There was indeed mountingevidence that some developing countries which had adopted very liberalpolicies on MNEs, with no regulation on transfer-pricing and relatively

an increasing number of well-reasoned analyses convincingly demonstratedthat the early anxiety about transfer-pricing practices of MNEs had beenunderpinned by misconceptions about what the phenomenon was all about

As a key proponent of the early view subsequently admitted, ‘most of theevidence [of transfer-pricing] came from one industry, pharmaceuticals, and

what would be charged by a non-patent observing imitator [and this

more than an imitating one’ (Lall 1983b, p 13)

Secondly, the palpable ideological shift in development thinking awayfrom import-substitution to export-oriented development strategy was

naturally accompanied by a greater receptivity to MNE participation indomestic production In this policy transition, the role of MNEs in theintroduction of new industries or new products to the host country and thetighter linking of the host country to the world trading system began toattract increased policy attention This ideological shift received furtherimpetus in the 1990s from the demise of central planning and widespreadrenaissance of the market economy as the dominant socio-institutionalsystem for resource allocation.

Thirdly, the virtual disappearance of commercial bank lending to oping countries in the early 1980s compelled many countries to look for

assistance had persistently lagged behind announced aid commitments aswell as the investment needs of the recipient countries, liberalization ofrestrictions on incoming foreign investment turned out to be a naturalpolicy choice

Finally, the passage of time had itself soothed some of the greatest fearsabout MNEs and both host countries and multinationals have come someway during the past quarter century in accommodating themselves to theexistence of one another In a related new development, labour unions andother non-governmental organizations in home countries have been learn-ing to use the multinationals as levers for the achievement of new goals,such as preventing international pollution, promoting religious freedomand discouraging the use of child labour These developments have begun

and host countries (Vernon 2000)

SCOPE AND PREVIEW

The great confrontation extending over the developing world between thenational state and the MNEs is certainly in the past It is now widelyaccepted that MNEs have the potential to play an important role in eco-nomic development, not only by bringing in new capital but also, and moreimportantly, by referring modern technology, market know-how andmodern management practices to developing countries

This broader consensus by no means implies that the governments in hostcountries have no role in regulating MNE entry to their countries or in regu-

in policy focus from the early confrontational approach to giving freshattention to tackling the challenges associated with relying on MNEs as avehicle for achieving developmental objectives through global integration.Although the general role of MNEs in development is well recognized, there

is no consensus on appropriate national policies toward MNEs; the extentand form of government regulations relating to both MNE entry and their

among countries

Improved development outcomes from relying on MNEs as ment partners are clearly tied to our ability to cast a fresh look at the impli-cations of the increasing role of MNEs in the global economy for domesticeconomic governance in host countries Over the past two decades, therehas been a boom in academic research analysing the economics of MNEs,but very few attempts have been made to address key issues in this policydebate This book, which examines selected issues relating to theMNE–development interface with emphasis on the experiences of devel-

Asia provides an excellent laboratory for studying the selected (and related)issues, given the variety of experiences relating to the nature and extent ofMNE involvement and the related policy regimes, both across countries ingeneral and over time within most countries In each chapter, the Asianexperience is examined in the context of the existing literature on the pat-terns and developmental implications of MNE involvement in the globaleconomy

Following this introductory chapter, Chapter 2 sets the context for theensuing chapters It begins with a succinct account of the evolution over thepost-war years and the current state of national policies toward MNE par-ticipation in developing Asian countries This is followed by an overview ofthe comparative performance of the developing Asian countries as hosts to

indicator of MNE participation The chapter also examines the emerging

makes inferences about prospects for attracting FDI in the context of the

coun-tries in the region of China’s emergence as an attractive location for FDI.Chapter 3 takes a fresh look at the role of MNEs in the expansion ofmanufacturing exports The analysis here is motivated by the concern that,given major changes in the investment climate in developing countries and

in patterns of international production over the past two decades, evidencefrom the early experience of the newly industrialized countries (NIEs) inEast Asia may send the wrong signals to policy makers in latecomer export-ing countries First a typology of the involvement of MNEs in manufac-turing for export is developed, based on the premise that MNEs are not a

The typology is then applied to empirical evidence from NIEs and comer exporting countries in developing Asia The evidence suggests that

late-the share of MNEs in manufactured exports from all countries has

Japan), the entry of MNEs is virtually essential for the export success of

concomitant liberalization of trade and investment policy regimes in mining gains from export-led industrialization

deter-‘International product fragmentation’ – the splitting of the productionprocess into discrete activities which are then allocated across countries –has been a key factor in the rapid expansion of MNE involvement in theglobal economy over the past three decades Chapter 4 provides fresh estim-ates of the extent and growing importance of this phenomenon in worldmanufacturing trade and examines the implications of this phenomenonfor global and regional trade patterns, with special emphasis on countries

in East Asia, using a new data set culled from the UN trade database It isfound that, while fragmentation-based trade (trade in parts and compon-ents) has generally grown faster than total world trade in manufacturing,the degree of dependence of East Asia on this new form of internationalspecialization is proportionately larger than that of North America andEurope The upshot is that international product fragmentation has madethe East Asian growth dynamism increasingly reliant on extra-regionaltrade, strengthening the case for a global, rather than a regional, approach

to trade and investment policymaking

Chapter 5 deals with the current debate on the relative stability of FDI

onset of an economic crisis and during the subsequent economic collapse

equipped to withstand a crisis and to aid the recovery process by

In this chapter, these and related issues are analysed, drawing upon the

instru-mental in ameliorating the severity of economic collapse and facilitatingthe recovery process

emerging market economies in Asia and Latin America during the period

1985–2000 It is found that the degree of appreciation of the real exchange

countries than in their counterparts in Latin America, despite the fact that

of the economy The econometric evidence suggests that both the

experiences While real exchange rate appreciation is a phenomenon

appre-ciation of the real exchange rate in Latin America, where the importance

inter-national production in foreign direct investment receiving countries is anissue of obvious policy relevance and analytical interest, but one on which

by examining the determinants of productivity of international productionusing a cross section of data on overseas operations of manufacturing

proposition that, other things being equal, productivity gains from national production tend to be greater under a more open trade policyregime than under a restrictive regime There is also evidence of a

gains from international production

Chapter 8 examines patterns and determinants of overseas R&D iture of US-based manufacturing MNEs using a new panel data set over the

by the domestic market size, overall R&D capability and cost of hiringR&D personnel There is modest statistical support for the hypothesis thatgeographical distance has a positive impact on the R&D intensity of MNE

propensity varies among countries according to their stage of global nomic integration Intellectual property protection seems to matter largelyfor mature economies with complementary endowments There is no evi-

of the capital stock of MNEs and the R&D intensity of their operation

into technology creators as part of their foreign direct investment policy

Chapter 9 deals with an important, yet hitherto sparsely studied, issue

devel-oping countries, namely whether they bring in more appropriate technology

to host developing countries compared with their developed-country

avoids some of the major drawbacks of the few previous studies In a simple

MNEs generally do exhibit a higher degree of capital intensity than those

of their developing-country counterparts as well as indigenous privatefirms However, when controlled for firm attributes other than parentage

in other industries All in all, the results support the view that country MNEs adopt more appropriate technology only in those industrieswhere the range of technological possibilities is wide enough to enable

Finally, Chapter 10 examines the role of MNEs and foreign direct ment in the process of economic transition from ‘the plan to market’through a case study of the Vietnamese experience It surveys the evolution

invest-of FDI policy in Vietnam in the context invest-of overall policy reforms andthe current state of the investment climate, and examines the experience ofattracting FDI from a comparative regional and global perspective This

is followed by an analysis of the impact of the operations of MNE

ample support for the view that both the rate of FDI involvement in theeconomy and the national developmental gains from FDI depend cru-

privatization/restructuring of state-owned enterprises, market-based sion making and the creation of a legal and institutional framework for

deci-foreign and private domestic investment.

NOTES

1 In line with usual practice in this area of study, the multinational enterprise (MNE) is

de fined here as an enterprise that owns and controls business ventures in more than two countries (including its home country).

2 FDI is ‘the category of international investment that reflects the objective of a resident

entity in one economy to obtain lasting interest in an enterprise resident in another

country’ (IMF 1993, p 86, emphasis added) Here the resident entity is the direct investor (the MNE) and the enterprise is the direct investment enterprise (the foreign affiliate) The

lasting interest implies the existence of a long-term relationship between the MNE and

the a ffiliate and a significant degree of influence by the former on the management of the latter It is this lasting interest that distinguishes direct investment from portfolio invest- ment and other forms of international capital flows such as foreign aid and commercial bank lending.

3 Data reported in this paragraph are from the UNCTAD World Investment Report base (www.unctad.org).

data-4 Unlike ODA, FDI is concentrated in a handful of developing countries However, in recent years FDI in flows have surpassed ODA in the bulk of developing countries, includ- ing the least developed countries (LDCs) (UNCTAD 2005).

5 Limitations of FDI as an indicator of the activity of MNE a ffiliates in host (investment receiving) countries are discussed in Chapter 2.

6 Lipsey (2004) provides an extensive survey of the related literature.

7 For an extensive survey of this literature, see Helleiner (1989).

2 Foreign direct investment in

developing Asia: trends, patterns and prospects

The purpose of this chapter is to provide the context for the ensuing ters It begins with an overview of the evolution and the current state ofnational policies toward MNE participation in Asian developing coun-

enterprises (MNEs) as measured by foreign direct investment (FDI), withemphasis on the relative position of developing Asian countries as hosts to

back-drop of global trends, and emerging patterns of source-country and

FDI is the commonly used and readily available measure of globaloperations of MNEs In addition to measurement problems involved inbalance of payments records of FDI (to be discussed below), this measure

host countries (UNCTAD 2001, Lipsey 2004) For instance, the parentcompany may take a minority ownership position in a foreign subsidiarybecause of ownership restrictions imposed by the host country or forother strategic reasons and yet control the activities of the latter, givenits command over production technology, management practices and

related, or even in the same host country Moreover, given scale economies

indus-tries and sectors of production, a given level of FDI could well imply

limitations, direct performance indicators such as sales, output or

operations in host countries Unfortunately such indicators are not able for most countries, including a large number of developed countries

avail-12

POLICY CONTEXT

The term ‘foreign investment regime’ (or policies toward MNE cipation in the national economy) is used here in the broader sense to

to investors Foreign investment regimes of Asian countries have gonethrough several changes in the post-war period As an integral part of a pal-pable shift away from import-substitution towards export-oriented devel-opment strategy, the policy regimes have become more liberal over time, notonly in the sense of reduced bureaucratic impediments to the entry of

been expanded From about the late 1980s, if there is a concern about FDI

commit-ment to FDI promotion and timing of related policy shifts during the crisis era

pre-Hong Kong

Hong Kong is in a class of its own in terms of its long-standing laissez-fareapproach to foreign direct investment Historically, Hong Kong evolvedeconomically as an entrepot for South China and politically as a colony ofGreat Britain Consequently, it is unique for its well-established tradition

of free trade and investment (Lin and Mok 1985) This policy stance has

so far remained intact in spite of Hong Kong becoming a SpecialAdministrative Region of China in 1991 Business licensing does not exist

are across-the-board low income taxes for all investors There are no specialtax incentives for foreign investors

Korea and Taiwan

Korea and Taiwan (like Japan) have historically adopted a more cautiousapproach to FDI as a means of developing indigenous technological cap-ability During the import-substitution phase of industrialization during thepost-war period up to about the late 1960s, foreign investment was welcomedinto the light manufacturing export sector, but the overall policy stancetowards foreign investment continued to be passive and highly selective

the attraction of foreign capital was made in January 1960, through the

enactment of the Foreign Capital Inducement Promotion Act This

Year Plan, begun in 1962, the government realized the importance offoreign capital, and thus adopted more concrete measures to encourage

FDI approval guidelines and procedures were further streamlined in 1973

stage of entrepreneurial development The most important change was thatincreased emphasis was placed on encouraging the setting up of joint ven-

relating to project eligibility, foreign equity share and investment scale were

clearly demarcated These heavy-handed criteria remained the backbone ofKorean FDI policy until the late 1970s (Koo 1985)

There was a notable move toward FDI liberalization from the early1980s, following the failure of the Heavy and Chemical Industry Promo-tion Plan of the 1970s Investment approval guidelines were considerablyliberalized in September 1980, allowing FDI in many new areas, permittingfirms to be majority- or wholly-owned by foreign investors in manyadditional cases and reducing the minimum amount of investment InDecember 1989, various performance requirements imposed on foreign-

technology transfer, were abolished In December 1996, when Korea joinedthe OECD, a new Act on Foreign Direct Investment and Foreign CapitalInducement replaced the Foreign Capital Inducement Act The new actaimed to provide the setting for a shift in FDI policy away from the historic

notwithstanding, Korea’s overall stance towards FDI continued to be quiterestrictive by the Southeast Asian standards (Kim and Hwang 2000)

govern-ment departed radically from its traditional closed economy approach

to FDI As part of its crisis management policy, the Korean governmentembarked on a more active promotion of FDI In November 1998, aspart of the reform program agreed with the IMF, the government enactedthe Foreign Investment Promotion Act, with a view to creating an investor-oriented policy environment The act provided for streamlining foreigninvestment approval procedures, expanding investment incentives, and theestablishment of an institutional framework for investor relations There

acquisitions and foreign land ownership In June 1998, the government

OECD as part of its commitment to the World Trade Organization (WTO),

thus contributing to strengthening investor confidence in the new FDIliberalization drive.

Under the new Foreign Investment Promotion Act, foreign investmentrestrictions were eased across a wide range of sectors, including banks,

included permitting foreigners to engage in deep-sea foreign transport;increasing the foreign ownership ceiling on publishing newspapers to 30 percent and periodicals to 50 per cent; increasing the permitted equity owner-ship by foreigners of Korean telephone service provision from 33 to 49 per

participation in merchant banks up to 100 per cent; and abolishing tions on foreign ownership of land and real estate properties on the basis

restric-of national treatment

1960), the government discouraged FDI in order to promote a new nous industrial entrepreneurial class In 1952 the government promulgatedlegislations to encourage investment in productive enterprises by overseasChinese and Chinese residents in Hong Kong and Macao These investorswere permitted to invest in any industry – real estate and services industries

indige-in particular From about the early 1960s, the policy regime became morereceptive to non-Chinese foreign investors But, as in Korea, the govern-ment played a very active role in directing investment into selected sectors/industries in line with national developmental priorities (Ranis and Schive

vicinity of Kaohsiung, Taiwan’s largest harbour, was established in 1966

continued to be the general thrust of the industrial policy of Taiwan untilthe mid-1980s Competition from foreign investors was structured in such

‘spillovers’ (Amsden and Chu 2003)

The Taiwanese FDI policy has become increasingly liberal as part ofmarket liberalization reforms beginning in 1986 Among other measures,

on joint ventures, opening markets to new foreign entrants in virtually allmanufacturing industries However, until recently, the government contin-

ser-vices such as banking and telecommunications (Amsden and Chu 2003)

Restrictions on foreign investment in services were later selectively lifted

as part of the reform process leading to Taiwan becoming a WTO member

in 2002

ASEAN Countries

Among the member countries of the Association of South East AsianNations (ASEAN), Singapore has throughout maintained a solid reput-ation for providing the most favourable FDI regime in the region (and one

of the most favourable in the world) (Chia 1985, Hughes and You 1969).The entry of FDI to Singapore is largely unrestricted and there is no need

investment law Nor are there restrictions on repatriation of funds orregulations concerning foreign ownership Remaining restrictions on FDI

in telecommunications and legal services were lifted in 2000 as part of eralization commitments under the World Trade Organization

lib-The main form of encouragement for foreign and domestic investorsalike remains the ‘pioneer status’ introduced by the Pioneer Industries

years, which may be extended depending upon possible additional

bring in new technologies The liberal FDI regime in Singapore is an ral part of an overall economic policy regime which has maintained animpressive track record in meeting other prerequisites of a good investment

market-friendly labour market practices, and transparent/expedient legal

In the 1960s and 1970s, policy towards FDI in the other four originalASEAN member countries (Indonesia, Malaysia, Thailand and thePhilippines) remained ambivalent, alternating between a national distrust

the technology and capital for rapid industrialization (Lindblad 1998,Chapter 5) FDI policy was thus characterized by a mix of incentives andrestrictions, with the balance between the two varying among countries andover time depending on the strength of prevailing anti-FDI sentiment(which was particularly strong in the Philippines and Indonesia) Theinvestment regime of Malaysia, which remained relatively liberal byregional standards in the 1960s, became much more restrictive following

the introduction of bumiputra ownership and employment requirements

under the New Economic Policy (NEP) (Athukorala and Menon 1996).The other countries gradually began to introduce pro-active FDI policies,

including offering various fiscal incentives But foreign participationremained generally limited to minority ownership Only pioneer statuswould qualify for full foreign ownership during the initial stage of opera-tions Unlike in India, however, there were no restrictions on procurement

From the late 1980s, as an integral part of a palpable shift away fromimport-substitution towards export-oriented development strategy, FDIpolicy regimes in these countries have become increasingly liberal By the

common feature and ownership restrictions had become increasingly liberal

requirement for registering with the Board of Investment had been

equity in the Philippines In other countries formal approval remained inforce, but the approval procedures had become much simpler and less timeconsuming All countries had moved to the so-called ‘negative list’ approach

to investment approval, which involves governments explicitly listing thoseactivities closed to FDI, with the implication that any activity not so listed

is open However, the governments continued to restrict foreign ation in such services as media, real estate, energy and utilities

global integration through FDI occurred in a general economic settingwhich became increasingly conducive to private sector participation in thegrowth and development process The investment environment had becomeincreasingly favourable for a number of reasons, including political stabil-ity and policy continuity, an impressive record in maintaining macroeco-nomic stability, and a proven track record in meeting infrastructurerequirements for rapid growth Beneath these general trends, there were

Malaysia was generally considered to have the most favourable foreigninvestment climate in the region (after Singapore), followed by Thailand,Indonesia and the Philippines in that order (Lindblad 1998, Hill 2004)

countries (Indonesia, Malaysia, the Philippines and Thailand) embarked

on a more active promotion of FDI In Thailand, nearly all services andmanufacturing sectors were opened to FDI and restrictions on FDI in the

policies that Thailand agreed to implement in the context of its request forfinancial support from the IMF (Kohpaiboon 2006)

In Indonesia, as part of the reform package agreed upon with the IMF,the government committed itself to promote foreign direct and equity

investment and to implement a number of measures to increase theseflows In late 1999, the Indonesian Government proposed to reorganizethe Investment Board (BKPM) into a new institution under the

invest-ment promotion rather than regulation activities Impleinvest-mentation of theseproposals has been hampered by political turmoil Measures implemented

investment (in July 1998) and lifting restrictions on foreign investment inwholesale trade

Malaysia has continued to give priority to promoting FDI, despite itsradical policy shift in September 1998 (Athukorala 2002a) The newly intro-

at making it harder for short-term portfolio investors to sell their shares and

With the exception of limits on foreign exchange for foreign travel byMalaysian citizens, there was no retreat from the country’s long-standingcommitment to an open trade and investment policy No new direct controls

repat-riation of capital by foreign investors continued to be free of control.Immediately following the imposition of capital controls, the Central Bank

of Malaysia (Bank Negara Malaysia, BNM) did experiment with new latory procedures in this area But these were swiftly removed in response to

to further encourage FDI participation in the economy These includedallowing 100 per cent foreign ownership of new investment made before

31 December 2000 in domestic manufacturing regardless of the degree ofexport orientation; increasing the foreign ownership share in telecommuni-cation projects from 30 to 69 per cent (on condition that the ownership share

com-panies and the insurance sector from a previous uniform level of 30 per cent

to 49 and 51 per cent respectively; and relaxing restrictions on foreign ment in landed property to allow foreigners to purchase all types of prop-erties above RM 250 000 in new projects or projects which are less than 50per cent completed In the Philippines, the crisis itself has not resulted in a

empha-sis on the promotion of export-oriented foreign investment, which started

in earnest in the late 1980s, seems to have received further impetus ing the crisis (Hill 2003)

opening of the economy to FDI was part of the ‘renovation’ (doi moi)

reforms initiated in 1986 (Riedel and Comer 1997, Freeman 2004) With

under-taken in the first half of the 1990s The reform process lost momentumduring 1996–98 partly owing to the East Asian crisis of 1997–98, but partly(perhaps even more so) owing to domestic policy ambivalence and com-placency resulting from the success of the initial reforms There has

In Cambodia the Kampuchea People’s Revolutionary Party (KPRP)government embarked on a market-oriented reform process in 1985 Aspart of these reforms, the government promulgated a liberal foreign invest-ment code in July 1989 and a National Investment Council was set up in

1991 with the task of reviewing all foreign investment applications Theoutcome of these reforms was somewhat lacklustre, however, and perhapsunsurprising given the continuing warfare between KPRP forces and theKhmer Rouge As an outcome of the UN-led peace process, elections wereheld in July 1993 and a multi-party democratic government was established

in September 1993 The new government set up the Cambodian InvestmentBoard (CIB) under the Council for Development of Cambodia (CDC) to

be the ‘one-stop’ service organization responsible for approving foreigninvestment applications The new Laws and Regulations on Investment inthe Kingdom of Cambodia, passed by the National Assembly on 4 August

package which was very generous compared with those in other countries

in the region

The foreign investment regime in Cambodia underwent an overhaul in

2003 The revised Law on Investment came into force on 27 September 2005,and represented a major attempt to equalize incentives for foreign and localinvestors, to achieve greater transparency in incentives provided, and tominimize distortions and delays arising from policy maker discretion Aspart of the new reforms, a fast-track procedure has been introduced with theaim of approving investment applications within a 14-day period under the

‘one-stop’ service at the CIB Seven working groups, which involve bothprivate and public sector participation, have been set up in key sectors towork in collaboration with the CIB to facilitate speedy investment approval,monitoring and promotion An investor forum, headed by the prime minis-ter, is to be held twice a year as part of the new investment regime InDecember 2005, a Sub-Decree was passed to provide the legal frameworkfor setting up special economic zones (SEZs) (which may include generalindustrial zones and/or export processing zones (EPZs))

The transition to a market-oriented economy in Lao PDR began in 1985with the announcement of the New Economic Mechanism, a majorprogram of economic reforms As part of the reform program a ForeignInvestment Code was passed in July 1988 and the Foreign Investment

Management Committee (FIMC) was set up under the direct purview of theprime minister to act as the apex agency that approves, monitors and pro-motes FDI At the initial stage, the prime objective of FDI policy inLao PDR was to engage foreign investor participation in restructuring ofstate-owned enterprises (SOEs) The Foreign Investment Code was sup-planted in July 1994 by the Law on Promotion and Management of ForeignInvestment, which was in turn substantially revised in October 2004.Foreign investment is now permitted in joint ventures or fully foreign-ownedprojects in all business sectors, except in mining and energy projects in whichthe government contributes to share capital or retains the right to buy a pre-agreed share of equity The structure of tax incentives for foreign investorshas been designed to take into account the country’s peculiar geography

parts of the country For large projects in the mining and energy sectors

taxation arrangements are negotiated on a case-by-case basis Finally, inMyanmar the potential for attracting FDI investment has remained sub-dued because of continuing political problems (Athukorala et al 2000)

China

1979 has been the opening up of the economy to foreign direct investment

the nature of joint ventures that would be allowed to invest in China andset the stage for the process of establishing an institutional and adminis-

relating to foreign investment were introduced between 1979 and 1986(Lardy 2002, Huang 2003, Pomfret 1991)

The centrepiece of China’s formal FDI promotion policy has been thespecial economic zones (SEZs) Chinese authorities chose SEZs as a com-promise solution to the problem of introducing foreign investors and theircapital participation into China while limiting the political repercussions ofopening up The original inspiration for the SEZs came from the EPZs ofEast Asia, but they have special Chinese features The SEZs are much largerthan EPZs Unlike EPZs elsewhere in the region which are typically run bymanagement companies or boards which come under the purview of thecentral government, SEZs are government units in their own right In terms

of objectives, the SEZs were not just to be vehicles for expanding exports.They were also assigned a central role in the reform process as ‘windows

and bridges’ to the outside world, in both directions, and also as ‘economiclaboratories’ in which economic policy experiments could be tried out in ageographically restricted area.

A striking feature of the FDI regime as it evolved in the 1980s wasits dualistic nature The export-oriented (EO) or export-promotion (EP)

some of the special provisions to attract FDI which until then had beenavailable only in the SEZs were made much more widely available At thesame time sectors such as retailing, power generation and port develop-

domestic market access has been given to foreign investors, particularly

in property development (including residential housing) was liberalized inthe early 1980s

South Asia

perhaps the most inward-oriented group of countries in the world outsidethe communist bloc These countries maintained strict controls on foreigninvestment in import-substituting manufacturing and other sectors whilegiving special incentives for export-oriented investment Technology licens-

foreign investment Naturally, the latter policies were not to bring about anytangible result, given the anti-export bias in the overall incentive structure.Sri Lanka took the lead in breaking away from the protectionist past, byembarking on a decisive process of economic opening in 1977 Followinghesitant and sporadic attempts to dismantle trade barriers in the 1970s,

countries seemed to have moved into a seemingly irreversible process ofeconomic liberalization and greater receptivity to foreign investment

policy with respect to FDI (and other types of foreign capital) remainedhighly restrictive, as part of a stringent import-substitution industrializa-

wanted it on its own terms With a view to minimizing foreign exchangeoutlay relating to technology acquisition, as far as possible technologieswere to be acquired through licensing rather than through FDI All foreigninvestment applications were considered on a case-by-case basis and thattoo within a normal ceiling of 40 per cent of total equity investment Major

commercial banks and foreign oil companies were nationalized in the

dilute their foreign equity holdings to 40 per cent if they wanted to be

property rights For instance, product patents were abolished in industriessuch as pharmaceuticals and chemicals and the duration of process patentswas drastically reduced The regulatory mechanism governing the entry ofMNEs was characterized by an explicit preference for technical collabor-ation agreements as opposed to FDI; a policy stance dictated by the desire

business operations and gaining access to foreign technology

In the mid-1960s, India set up two free trade zones (FTZs) to promoteexport-oriented foreign investment alongside the highly restrictive trade

reasons, such as their relatively limited scale, the government’s generalambivalence about attracting FDI, the unclear and changing packagesattached to the zones, and the power of the central government in the regu-lation of the zones (Bajpai and Sachs 2000, Kumar 1989)

In the 1980s, there was some softening of the FDI approval procedurefor export-oriented activities and some high-tech industries, but the overallpolicy stance remained one of the most stringent in the developing world.Foreign investment policy was substantially liberalized at an early stage ofthe 1991 economic reforms and the process was extended further in the sub-sequent years (Balasubramanyam and Mhambare 2003) Foreign owner-ship up to 51 per cent is now permitted in a wide range of industries.Foreign ownership up to 100 per cent is permitted on a case-by-case basis

in some designated (priority) areas (pharmaceuticals, airports, suburbandevelopment, hotels and tourism, courier services and mass rapid transportsystems) and up to 74 per cent in the telecommunication sector Technologypolicy has been reformed to give greater recognition to intellectual property

requiring only registering with the Reserve Bank of India (RBI) Firms arenow free to negotiate the terms of technology transfer on the basis of theirown commercial judgment and without the need for government approvalfor hiring of foreign technicians and foreign testing of indigenously devel-oped technology

tension between the traditional aversion to foreign investment and

example, FDI is still not permitted in pure retailing; global retailerscan only participate in India’s retail sector through wholesale trade or byoperating retail outlets through local franchises In apparel and other light

consumer-good producing industries, which are important in exportexpansion and job creation at the current stage of economic development

of the country, FDI is limited to 24 per cent of total equity Restrictions onforeign ownership of land limit the entry of foreign builders and develop-ers into the construction sector (see World Bank 2003b, pp 55–66 fordetails) Projects with 51 per cent or more foreign ownership still require along procedure of government approval

There are also many unresolved problems relating to the overall

substantially higher than in most other developing countries, and this tinues to block India’s attractiveness as an export platform for labour-intensive manufacturing products While the ‘Licence Raj’ (the infamousindustrial licensing policy) has been largely eliminated at the centre, it stillsurvives at the state level, along with a pervasive ‘Inspector Raj’ Privateinvestors require a large number of permissions (for electricity and watersupply connections, water supply clearance and so on) from state govern-ments to start business and they also have to interact with the state bureauc-

bank-ruptcy framework are other prominent issues

Pakistan has a checkered history of trade liberalization and FDI motion Following some trade liberalization attempts in the 1960s,

mid-1980s there was still a long way to go in lifting QRs and reducing

manufactur-ing have diminished sharply, those for the service sector less so

In spite of various bureaucratic controls, the government attitudethroughout the 1950s and 1960s was favourable to private investment (Bose

1983, Guisinger and Scully 1991) The FDI regime was more liberal,although there was greater emphasis on joint ventures with minorityforeign ownership and technology licensing than on FDI in fully foreign-owned ventures However, supremacy of the state and socialist ideologyunder a socialist government dominated policy in the 1970s As a result, alarge-scale program of nationalization of key industrial units and wide-spread control of domestic and foreign trade were instituted The dismaleconomic outcome of the interventionist policies eventually paved the wayfor market-oriented reform Reforms started slowly in the early 1980s aspart of a widespread reform package in conformity with the World Bankconditionality Removal of restrictions on foreign investment was a major

in almost all sectors of the economy