Nafziger Economic Development (4th ed)

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TABLE 15-5 (continued)

Note: Thirty high-income countries (see cover) were omitted from the table.

aGDP for countries and value added for MNCs. Value-added is defined as the sum of salaries, pretax profits, and depreciation and amortization.

bValue-added is estimated by applying the 30 percent share of valueadded in the total sales, 2000, of manufacturers for which the data were available.

cValue-added is estimated by applying the 16 percent share of valueadded in the total sales, 2000, of trading companies for which the

data on value-added were available.

dValue-added is estimated by applying the 37 percent share of valueadded in the total sales, 2000, of other tertiary companies for which the data on value-added were available.

Source: UNCTAD 2002c:90–91.

concerns within the host economy. These affiliates arrange their own subcontractors, suppliers, and marketing, with some even located in third countries.

From 1988 to 1992, LDCs, under pressure by creditors to privatize public enterprises, sold 17 percent of their medium-sized and large state-owned enterprises to foreign direct investors. In Eastern Europe and the former Soviet Union, 1988 to

1992, FDI from privatizing state-owned enterprises comprised 67 percent of total FDI inflows to that region (UNCTAD 1994b:26).

Additionally, in some industries, control over global marketing and financing still gives MNCs much power in determining the supply and price of LDC primary exports. For example, three conglomerates account for 70–75 percent of the global banana market; six corporations, 70 percent of cocoa trade; and six MNCs, 85–90 percent of leaf tobacco trade (Economic Commission for Africa 1983a).

Yet, ironically in some instances, MNCs may increase competition because their intrafirm transactions break down barriers to free trade and factor movement between countries. By contrast, once MNCs are established in an economy, they may exploit their monopolistic advantages and enhance concentration. Thus, MNCs, which accounted for 62 percent of manufacturing’s capital stock in Nigeria in 1965, contributed to high rates of industrial concentration. Yet a subsidiary’s production that dominates a LDC industry may be only a fraction of the parent company’s output and peripheral to the MNC’s decision-making process (Kindleberger 1974:267–285; Nafziger 1977:55–60).

You may have already sensed that leaders in LDCs do not agree on whether MNCs are beneficial or not. Some emphasize that MNCs provide scarce capital and advanced technology essential for rapid growth. Others believe such dependence for capital and technology hampers development. In the next two sections, we summarize the benefits and costs of MNCs in less-developed countries.14

The benefits of MNCs. MNCs can help the developing country to

1.Finance a savings gap or balance of payments deficit.

2.Acquire a specialized good or service essential for domestic production (for example, an underwater engineering system for offshore oil drilling or computer capability for analyzing the strength and weight of a dam’s components).

3.Obtain foreign technology and innovative methods of increasing productivity.

4.Generate appropriate technology by adapting existing processes or by means of a new invention.

5.Fill part of the shortage in management and entrepreneurship.

6.Complement local entrepreneurship by subcontracting to ancillary industries, component makers, or repair shops; or by creating forward and backward linkages.

7.Provide contacts with overseas banks, markets, and supply sources that would otherwise remain unknown.

8.Train domestic managers and technicians.

9.Employ domestic labor, especially in skilled jobs.

10.Generate tax revenue from income and corporate profits taxes.

11.Enhance efficiency by removing impediments to free trade and factor movement.

12.Increase national income through increased specialization and economies of scale.

14Sources for these two sections are Muller¨ (1979:151–178); Streeten (1973:1–14); Lall (1974:41–48); and Buffie (1993:639–667).

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The costs of MNCs. Some economists and third-world policy makers have questioned whether MNC benefits exceed costs. These critics charge that MNCs have a negative effect on the developing country because they

1.Increase the LDC’s technological dependence on foreign sources, resulting in less technological innovation by local workers.

2.Limit the transfer of patents, industrial secrets, and other technical knowledge to the subsidiary, which may be viewed as a potential rival (Adikibi 1988:511– 526). For example, Coca-Cola left India in 1977 rather than share its secret formula with local interests (although in 1988–89 it reentered India, but without sharing its formula, to forestall dominance by Pepsi Cola’s minority-owned joint venture).

3.Enhance industrial and technological concentration.

4.Hamper local entrepreneurship and investment in infant industries.

5. Introduce inappropriate products, technology, and consumption patterns (see Nafziger, 2006b:Box 15-2, “Infant Feeding and the Multinationals”).

6.Increase unemployment rates from unsuitable technology (see Chapter 9).

7.Exacerbate income inequalities by generating jobs and patronage and producing goods that primarily benefit the richest 20 percent of the population.

8.Restrict subsidiary exports when they undercut the market of the parent company.

9.Understate tax liabilities by overstating investment costs, overpricing inputs transferred from another subsidiary, and underpricing outputs sold within the MNC to another country.

10.Distort intrafirm transfer prices to transfer funds extralegally or to circumvent foreign exchange controls.

11.Require the subsidiary to purchase inputs from the parent company rather than from domestic firms.

12.Repatriate large amounts of funds – profits, royalties, and managerial and service fees – that contribute to balance of payments deficits in the years after the initial capital inflow.

13.Influence government policy in an unfavorable direction (for example, excessive protection, tax concessions, subsidies, infrastructure, and provision of factory sites).

14.Increase foreign intervention in the domestic political process.

15.Divert local, skilled personnel from domestic entrepreneurship or government service.

16.Raise a large percentage of their capital from local funds having a high opportunity cost.

On the last point, Ronald Muller’s¨ (1979:151–178) evidence from Latin America indicated that MNCs contribute only 17 percent, and local sources 83 percent, of the financial capital. However, Muller¨ includes as local capital the subsidiary’s reinvested earnings and depreciation allowances. If this source is excluded, local financing accounts for 59 percent of total capital. Still, if the figure is representative

of developing countries as a whole, MNCs contribute less than generally believed. Moreover, even if local individuals and financial institutions contribute only 20 to 30 percent, this amount represents substantial funds that invested elsewhere might better meet the country’s social priorities.

Southern Africa illustrates MNC cost. Between 1960 and 1985, almost half the Western MNC investment in Africa was in the Republic of South Africa, supporting not only apartheid there but also harming the neighboring countries’ development. The MNCs and the Pretoria government viewed South Africa as the core for their expanding activities throughout other parts of southern Africa, which provided labor, a market, and raw materials. The MNCs with subsidiaries also in South Africa’s neighboring countries dominated their banking systems, invested much of these countries’ financial capital in South Africa, shipped raw materials for processing from them to South Africa, and neglected their manufacturing and (sometimes) mining industries. These neighbors bought capital goods, some consumer goods, and even foodstuffs from South African MNCs. Until the 1980s, the international copper companies in Zambia, Zaire, Botswana, and Namibia built most fabricating factories in South Africa or the West (Seidman and Makgetla 1980).

The MNCs and LDC economic interests. The MNC benefits and costs vary among classes and interest groups within a LDC population. Sometimes political elites welcome a MNC because it benefits them through rakeoffs on its contract, sales of inputs and services, jobs for clients, and positions on the boards of directors (even though the firm harms the interests of most of the population). However, as political power is dispersed, elites may have to represent a more general public interest.

Since the early 1970s, there has been a shift in bargaining power away from the MNCs to third-world governments, which have increased their technical and economic expertise and added alternative sources of capital and technology. An increasing share of MNC investment is in joint ventures with LDC government or business. And LDCs have appropriated more of the monopoly rents from public utilities and mineral production. In the 1970s, the most visible change was the shift in the ownership of OPEC oil concessions from the international oil companies to OPEC member governments (see Chapter 13). Moreover, as a result of increasing LDC restrictions, some of the MNC role has shifted from equity investment, capital ownership, and managerial control of overseas facilities to the sale of technology, management services, and marketing. As LDCs become more selective in admitting MNCs, and more effective at bargaining, they increase the benefits and reduce the costs of MNCs (Streeten 1981:308–315).

Some economists, however, would argue that, since the mid-1980s, the bargaining power has shifted back somewhat to MNCs. Under IMF stabilization loans and IMFWorld Bank adjustment loans, LDCs have faced pressures to privatize and open their economies to foreign capital investment, policies that provide more opportunities for DC-based multinational companies.

Alternatives to MNC technology transfer. The LDCs can receive technology from MNCs without their sole ownership. Joint MNC–local country ventures can help

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LDCs learn by doing. Yet frequent contractual limits on transferring patents, industrial secrets, and other technical knowledge to the subsidiary, which may be viewed as a potential rival, may hamper learning benefits. Turnkey projects, in which foreigners for a price provide inputs and technology, build plant and equipment, and assemble the production line so that locals can initiate production at the “turn of a key,” are usually more expensive and rarely profitable in LDCs (which usually lack an adequate industrial infrastructure). Other arrangements include management contracts, buying or licensing technology, or (more cheaply) buying machinery in which knowledge is embodied. The late-19th-century Japanese government, which received no foreign aid, introduced innovations by buying foreign technology or hiring foreign experts directly. More recently, in the 1980s, the Chinese government-owned Jialing Machinery Factory in Chongqing improved the engineering of its motorcycles substantially by buying technical advice, machines, and parts, and licensing technology from Japan’s Honda Motor Company. Additionally, nonmarket sources of foreign knowledge include imitation, trade journals, and technical and scientific exchange, as well as feedback from foreign buyers or users of exports – all virtually costless (Nafziger 1986b:1–26; Nordquist 1987:66–71; see also Fransman 1986:11–14, who indicates major modes of transferring knowledge through the market).

Sanjaya Lall’s (1985:76) conclusion is sensible:

The correct strategy then must be a judicious and careful blend of permitting TNC [MNC] entry, licensing and stimulation of local technological effort. The stress must always be – as it was in Japan – to keep up with the best practice technology and to achieving production efficiency which enables local producers (regardless of their origin) to compete in world markets. This objective will necessitate TNC presence in some cases, but not in others.

LOANS AT BANKERS’ STANDARDS

In the 1960s, the LDC balance on goods and services deficit was financed primarily by flows from official or semiofficial sources in the form of grants, concessional loans, and market loans. Private finance during the 1960s consisted mainly of suppliers’ credits and direct foreign investment. Commercial bank lending increased in the decade after 1967. As pointed out earlier, private loans fell during most of the 1980s, increased during the early 1990s, but fell again during the late 1990s through 2003.

Nonconcessional loans from abroad finance a deficit in the balance on goods and services account. For LDCs, the ratio of official aid to commercial loans declined for a decade and a half after 1970: from 1.40 in 1970 to 0.66 in 1973 to 0.55 in 1975 to 0.36 in 1978 to 0.23 in 1984. Subsequently, the ratio of official aid to commercial loans rose from 0.23 in 1984 to 0.33 in 1987 to 0.47 in 1990 and 0.43 in 1994 to 0.95 in 2002. The increasing trend after the mid-1980s mostly reflected the fall in private lending rather than substantial growth in concessional assistance. By the late 1980s and early 1990s, low-income countries, with more than twice the population of middle-income countries, received twice the official assistance that middle-income countries did, in contrast to the 1970s, late 1990s, and early years of the 21st century,

when aid was relatively evenly divided among the country categories. However, all but a small fraction of commercial loans were to middle-income countries with high credit ratings (World Bank 1980i; OECD 1981; OECD 1982; World Bank 1981i:49– 63; Overseas Development Council 1982a:215–37; Overseas Development Council 1982b:225–46; IMF 1988d:96–109; IMF 1995d:161–67; OECD 2002b).

Two sources of lending fell in the late 1990s and early years of the 21st century:

(1) private lending as commercial bankers became unwilling to finance in the face of debt rescheduling and default (see Chapter 16), recent nonperforming loans, and more selective lending by individual banks, and (2) official (or officially supported) export credit finance (a part of short-term borrowing), and interest rates for bank finance fell.

However, one source of local LDC funding is expanding – local lending by multinational banks with headquarters in DCs. Affiliate banks of the major DCs in the Group of 1015 are increasingly lending in local currency, a trend that could reduce LDC debt in foreign currency. The local currency claims of G-10 bank affiliates in LDCs shot up from $30 billion in 1983 to $130 billion in 1996 to $490 billion in 2002, increasing the proportion of these affiliates’ claims on LDCs in local currency from 7 percent in 1983 to 20 percent in 1996 to 68 percent in 2002 (World Bank 2003e:51). This decreases currency mismatches in LDCs, a phenomenon in which banks hold assets in local currency and incur liabilities in foreign currency, making the banks vulnerable to losses from domestic currency depreciation.

Bilateral flows. OECD official development assistance is only a part of the total net flow of resources to LDCs. As indicated earlier, 0.22 percent of the 2001 GNP of OECD countries was foreign aid. However, additional net flows included private capital and bank loans – 0.96 percent of GNP, nonconcessional official flows – 0.04 percent of GNP, and private voluntary agencies – 0.03 percent of GNP. Thus, the total net flow was 1.25 percent of GNP (OECD 1995:C3–C4; UNCTAD 2003:4).

The Eurocurrency market. Eurodollars are dollars deposited in banks outside the United States, often by U.S. banks. More generally, Eurocurrency deposits are in currencies other than that of the country where the bank (called a Eurobank) is located. The Eurobank system began in the early 1950s when the Soviet Union, using the U.S. dollar for international trade and fearing the U.S. government might block its deposits in U.S. banks, transferred its dollars to English banks. These (and subsequently other European) banks could lend these dollars to MNCs, banks, governments, and other borrowers. Banks increased their profits by avoiding national exchange controls, reserve requirements, and bank interest ceilings, and depositors were attracted by receiving higher interest rates. In the mid-1990s, dollars comprised two-thirds of the more than $8 trillion deposits in this unregulated financial market, which is located in Europe (London, Zurich, Paris, Amsterdam, and Luxembourg), Hong Kong,

15The G-10, like the Big 10 conference, consists of 11: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States.

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Singapore, Tokyo, Kuwait, Nassau, Panama, Grand Cayman, Bahrain, and (in 1981 after U.S. banks could accept Eurodeposits) New York City. Eurobanks have played a role in lending to LDCs, including recycling petrodollars to oil-importing LDCs in the mid-1970s. Most deposits are by private nonbanks or by central banks and other official monetary institutions. Although the absence of reserve requirements and control by national monetary authorities provides substantial potential for the multiple expansion of bank deposits (and world inflation), in practice most loan funds are deposited outside Eurobanks, thus leaking out of the system (Ethier 1988:498– 509; Fusfeld 1988:799–801; Kenen 1989:453–454, 468–470; Krugman and Obstfeld 1994:642–651; Krugman and Obstfeld 2000:650–659).

Funds from multilateral agencies. In 1944, 44 nations established the World Bank, envisioned primarily as a source for loans for post–World War II reconstruction; and the IMF, an agency charged with providing short-term credit for international balance of payments deficits (see Chapter 5). Neither institution was set up to solve the financial problems of developing countries; nevertheless, today virtually all financial disbursements from the World Bank are to LDCs, and the IMF is the lender of last resort for LDCs with international payments crises.

The World Bank is a well-established borrower in international capital markets, issuing bonds denominated in U.S. dollars but guaranteeing a minimal Swiss franc value when the dollar depreciates. In the early years of the 21st century, the Bank, which is the largest source of long-term developmental finance for LDCs, provided about 10 percent of the total resource flows to LDCs. It lent more than $17 billion to LDC governments annually, including funds for investments such as water improvement and rural infrastructure in India, telecommunications and water supply in Afghanistan, mass transit in Brazil, a college of fisheries in the Philippines, irrigation and flood control in Indonesia, construction of hospitals, schools, roads, and sewage pipes in Argentina, and a Chad–Cameroon oil pipeline (although in 2004 environmental groups and other nongovernmental organizations challenged support by major international banks, LDC governments, and LDC mining companies of the World Bank continuing to finance LDC oil and coal projects) (World Bank 2004d; World Bank Development News, various issues). Furthermore, the World Bank has used its technical and planning expertise to upgrade projects to meet banking standards, has lent for development plans and economic reform, and has led in organizing consortium packages of lenders and grant givers. A World Bank affiliate, the International Finance Corporation, has invested $4 billion annually in agencies to stimulate private enterprise, such as the Industrial Credit and Investment Corporation of India, mentioned in Chapter 14. These amounts do not include soft loans (or concessional aid) of more than $6 billion annually made by another World Bank affiliate, the

International Development Association.

The IMF provides ready credit to a LDC with balance of payments problems equal to the reserve tranche – the country’s original contribution of gold – or 25 percent of its initial contribution or quota. Beyond that, other credit lines include the first credit tranche, with 25 percent of the quota, granted on adoption of a program to

overcome international payments difficulties; an extended facility, with 150 percent of the quota, based on a detailed medium-term program; a supplementary financing facility subsidy account, 140 percent of quota (financed by repayments from trust fund loans and voluntary contributions) to support standby arrangements for eligible low-income LDCs under previous programs; a compensatory and contingency financing facility (CFF), 75 percent of quota, to finance a temporary shortfall in export earnings or excess costs of cereal imports beyond the country’s control; buffer stock financing, 50 percent of the quota, to stabilize export earnings; an oil facility, funds borrowed from oil-exporting countries to lend at competitive interest rates to LDCs with balance of payments deficits; and a subsidy account, contributed by 25 DCs and capital surplus oil exporters that makes available interest subsidies to lowincome countries (Grubel 1981:531–533). To illustrate, the financial intermediation of the IMF enabled India to borrow $2.85 billion from Saudi Arabia in 1981 at an interest rate of 11 percent, compared to 18 percent in the commercial markets.

Yet, between 1983 and 1985, most special funding beyond direct IMF credits dried up, with net lending to LDCs falling from $11.4 billion to $0.2 billion, reducing IMF leverage to persuade LDCs to undertake austerity in the face of internal political opposition. However, from 1986 to 1988, the IMF added a structural adjustment facility (SAF), which provides concessional assistance as a portion of a package of medium-term macroeconomic and adjustment programs to low-income countries facing chronic balance of payments problems; added an enhanced structural adjustment facility, renamed the Poverty Reduction and Growth Facility (PRGF), “to foster durable growth” that raises living standards for the poorest IMF members making adjustments; and restored the CFF with an average grant element of 20 percent. The first two facilities were financed by a rotating fund from recycling the IMF Trust Fund (from the sale of IMF gold) and by Japan and European countries with external surpluses, but not the United States, which had an international deficit and was opposed to IMF long-term concessional aid. As an example of how this aid works, in 1988, the IMF approved $85 million ($35 million as SAF and $18 million as supplementary funding) for Togo, whose export earnings from cocoa, coffee, palm products, and peanuts had declined from 1985 to 1987 (Feinberg 1986:14–18; World Bank 1988i:141; IMF Survey, various issues) and, in 1996–2003, support for the initiative for highly indebted poor countries (HIPCs), “countries that pursue IMFand [World] Bank-supported adjustment and reform program, but for whom traditional debt relief mechanisms are insufficient” (IMF 2004) (see Chapter 16).

In 1999, in response to the Asian financial crisis of 1997–98, the IMF established Contingent Credit Lines (CCL), a precautionary defense for members with transparency and sound policies who might, however, be vulnerable to contagion from capital account crises in other countries. After four years of disuse, CCL was discontinued in 2003. Countries were reluctant to use the CCL, for fear of being labeled as subject to possible crisis!

In the IMF and World Bank, the collective vote of high-income OECD countries comprises a substantial majority of the total. The U.S. view of policy for LDCs is the most dominant among high-income OECD countries. The U.S. view (Summers

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1998:14) corresponds closely to IMF policy, as the United States, with 17.5 percent of IMF shares, only needs a few DC allies to deny an IMF loan. Indeed, Strom Thacker’s (1999) econometrics provides “strong evidence that the political interests of the U.S. drive much of the behavior” of the IMF. Robert Barro and Jong-Wha Lee’s (2002) analysis of IMF lending, 1975 to 1999, shows that an LDC’s political proximity to the United States (that is, the percentage of times that country voted in the U.N. General Assembly along with the United States) significantly increases the probability and size of an IMF loan.16 More explicitly, U.S. voting for IMF stabilization and structural adjustment lending for LDCs is significantly related to the recipient’s support of U.S. foreign policy stances. (A political and strategic motivation – to promote democracy and private enterprise and minimize Soviet influence in the third world – was important in congressional approval of President Harry Truman’s call in 1949 for U.S. “Point Four” economic assistance to LDCs.)

Columbia’s Jeffrey Sachs opposes IMF and World Bank structural adjustment programs in Africa, arguing that the Bretton Woods’ institutions cannot force good governance with their average of 117 loan conditions. These programs delegitimize African governments, increasing their vulnerability to overthrow, and do not emphasize diversifying production and promoting exports. The high-interest low-inflation strategies of the Fund and Bank were “suffocating economic growth” in Africa (PanAfrican News Agency 1998).

Chris Cramer and John Weeks (2002:43–61) evaluate how IMF and World Bank macroeconomic stabilization (monetary, fiscal, and exchange-rate policies) and structural adjustment (privatization, deregulation, wage and price decontrol, and trade and financial liberalization) programs affect economic growth and income distribution. These program, almost universal among LDCs after 1979, were mostly introduced in response to chronic macroeconomic imbalances and external deficits, and required borrowing from the IMF and World Bank as lenders of last resort. The standard orthodox packages, with emphases on compressing money demand, raising interest rates, and reducing the role of the state (Polack 1997:16–18), have cut economic growth and increased the probability of political instability.

Barro and Lee (2002) find that, other things held constant, IMF lending has no effect on economic growth during the simultaneous five-year period but has a significantly negative effect on growth in the subsequent five years. The Brandt report even contends that the IMF’s insistence on drastic measures in short time periods imposes unnecessary burdens on low-income countries that not only reduce basisneeds attainment but also occasionally lead to “IMF riots” and even the downfall of governments (Independent Commission on International Development Issues 1980:215–216). In 2004, the Independent Evaluation Office of the IMF stated that the PRGF’s achievements had “fallen short of the ambitious expectations set out in the original policy documents, [especially] in improving conditions in the world’s poorest

16Roubini and Setser (2004) are critical of IMF and DC rescue packages to support bailouts of countries that owe rich countries’ creditors and banks. The two authors favor smaller packages, implying only partial bailouts that “bail in” (or require losses from) U.S. and DC creditors that make risky loans to LDCs.

countries, . . . fail[ing] to address controversial policy issues as well as [lacking] clear benchmarks against which to monitor progress.” The report called for greater flexibility “to accommodate the diversity of country political and administrative systems and constraints” and asked “countries to define – in a manner open to public scrutiny – their own benchmarks and objectives for improving policy-making processes” (World Bank Development News, July 29, 2004).

Paul Krugman (1999:115) criticizes the IMF for its priority, in Thailand, Indonesia, Korea, and other Asian countries undergoing crisis in 1997, on raising taxes and cutting spending to reduce budget deficits and raising interest rates, adding perhaps tongue-in-cheek that “governments [must] show their seriousness by inflicting pain on themselves.” The effect was to reduce demand, worsening the recession and feeding panic.

Surely the IMF must be satisfied that a borrower can repay a loan. And there may be few alternatives to monetary and fiscal restrictions or exchange-rate devaluation for eliminating a chronic balance of payments deficit. Furthermore, as Chapters 16 and 19 indicate, the IMF’s PRDG may have recently put more emphasis on growth and efficiency and less on reducing domestic demand and attaining external balance. Moreover, although the third world’s collective vote in the IMF, based on member quotas, is 40 percent, LDCs often support DCs in laying down conditions for borrowing members so as not to jeopardize the IMF’s financial base. Furthermore, as Kenneth Rogoff, IMF Chief Economist, 2001–03, argues (2004:65), just because we see doctors around plagues doesn’t mean they cause them; just because IMF lending accompanies LDC austerity doesn’t mean the IMF is the cause.

Other major multilateral sources of nonconcessional lending in 2002 were the Inter-American Development Bank, the Asian Development Bank, the European Union, and other regional development banks.

Perverse Capital Flows: From LDCs to DCs

The Nobel laureate Robert Lucas (1990:92–96) asks: “Why doesn’t capital flow from rich to poor countries?” The law of diminishing returns implies that the marginal productivity of capital is higher in a capital-scarce, labor-abundant economy such as India than in the United States, a capital abundant country. Lucas estimates that, with an Indian worker of the same quality as an American worker, India’s marginal product of capital should be 58 times as in the United States. Even when Lucas concedes that one U.S. worker, with more human capital, may be as productive as five Indian workers, India’s predicted return to capital would still be a multiple of the return of the United States. Lucas surmises that DC capital in LDCs encounters capital market imperfections and restrictions, specifically, economic institutions and policies and political risks that make it difficult to enforce international borrowing agreements.

Moreover, would an MNC’s technology be the same in the headquarters and LDC affiliate? Perhaps not, as technology usually needs to be modified when shifted to a different economy and culture. Chapter 16 discusses capital flight in more detail.