Foreign Direct Investment

            Foreign Direct Investment is often regarded as a critical part of achieving industrialisation in developing countries. Within the framework of classical growth theory capital accumulation has a central role emphasising the need for investment. Foreign Direct Investment (henceforth FDI) goes beyond this role of assisting capital accumulation due to predicted effects such as the diffusion of new technology. It may be formally defined as a “Form of international inter-firm co-operation that involves significant equity stake and effective management decision power in or ownership of foreign enterprises.” (de Mello, 1999). This essay will argue that FDI is part of a successful recipe for industrialisation to a limited extent. The benefits of FDI will be discussed regarding how industrialisation is achieved. These being limited by the threshold conditions an economy must meet for FDI to be successful and the potential negative effects of FDI. This will be supported by evidence from the experience of economies in South East Asia.

Foreign Direct Investment can play a critical role in the industrialisation of a developing country due to its ability to improve growth through enhancing productivity, increasing competition, and enabling the spill-over of skills and technology. The critical element of FDI is the entry into the market of a multinational corporation (MNC) such that they look to produce goods of international quality at competitive prices (Calvo, Leiderman, & Reinhart, 1996). This can have an immediate impact on industrialisation as the MNC may choose to develop local infrastructure and introduce new technologies to support their production. This can involve developing roads, ports, and telecommunications often related to the needs of the relevant industry (Calvo, Leiderman, & Reinhart, 1996). The benefits of FDI go beyond this due to the incidence of technology spill-overs and vertical linkages. Spill-overs may occur as local firms observe and imitate MNCs, employees of MNC join local firms, and how the presence of MNCs may attract other high skilled services such as consultancy. This may enhance industrialisation as local firms gain information on how to more efficiently produce, use new skills, and exploit new information (Calvo, Leiderman, & Reinhart, 1996). The more prominent case for industrialisation through FDI is found in vertical linkages. MNCs have a considerable incentive to introduce technology to local firms that produce relevant inputs. As this enables the local firms to produce more at a lower cost to an international standard quality which can be achieved through training and quality control (Blalock & Gertler, 2008). MNCs will then want to avoid relying upon a single firm as this could lead to hold-ups such that they establish relationships with multiple local firms. This encourages competition amongst the vendors keeping prices lower ensuring sustained profits. The overall impact of this drives forward industrialisation as local firms improve their production techniques, exploit new technologies, and utilise any surplus captured to further enhance productivity. The beauty of this mechanism is that it operates entirely through the market such that policy intervention could be minimised to simply encouraging FDI reducing potential distortions. However, for the mechanism described above to operate such that it has a positive impact on industrialisation there are several threshold conditions which must be met, the issue of absorptive capacity, and then the potential negative effects of encouraging FDI to occur.

FDI may not result in successful industrialisation as a sole strategy due to factors which may limit its impact and quality, suggesting that alternatives must be implemented alongside it. Firstly, the limited impact of FDI on industrialisation may be viewed from the requirement of meeting threshold conditions. This involves matters such as quality over quantity, preparation for receiving FDI, consistency of government policies, promoting linkages, and how trade is facilitated (te Velde, 2001).[1] This case becomes apparent upon examining the success of FDI in promoting industrialisation between Sub-Saharan African economies and South East Asian economies. Considering the accumulated flows of FDI scaled to the size of the relevant economy countries such as Lesotho received more than Singapore (te Velde, 2001), yet they are far less industrialised. This is partially due to FDI being incident in extractive industries focused on the exploitation of natural resources rather than the aim of providing a strong productive base. Emphasising the need for certain types of FDI (the quality improving if incident in industries where there can be substantial technological gains) rather than sheer volume. Countries with poor levels of infrastructure and low human capital may not attract FDI in the first place as MNCs would need to provide this for their operations, such that the developing country must first seek to improve factors such as school enrolment or even telephone lines. Finally, there needs to be an emphasis on the role of the government how policy is practiced and whether there are suitable policies to enhance linkages and facilitate trade. Foreign investors will need assurance that capital controls will not return if they invest. Additionally, the setup of an Investment Promotion Agency (IPA) is critical as it increases the ease of business for MNCs such that they only need to coordinate with one body, and this can help the developing country to target certain kinds of FDI (te Velde, 2001). These factors and ensuring there is some level of existing skills and infrastructure would enhance the absorptive capacity of local firms such that they could reap the benefits of FDI.

FDI can potentially harm the industrialisation of developing countries, and at times government policy aligned to encouraging further investment may be less effective than alternative policies. FDI could lead to investment in industries where without the MNCs there would be no operations, this is especially problematic with resource extraction based investment where there is the repatriation of profits and then firms leave (Rodrik & Subramanian, 2009). MNCs would also look to limit any horizontal linkages to protect their rents, this may mean that even if industrialisation to a factor such as utilities occur it may no longer be worthwhile as people cannot afford to use them. There is also the potential for balance of payment related crises to occur given the financial mechanism of FDI which will be elaborated further regarding the South East Asian crisis. Alternative strategies can be used to directly target desired industrialisation namely in the form of import substitution industrialisation (ISI) and export promotion. The main advantage of these alternative strategies is their independence from foreign perceptions of the domestic economy, and are then not subject to sudden reversals. FDI may be beneficial as part of a larger industrialisation strategy but there are conflicting policy areas with alternative strategies (Rodrik & Subramanian, 2009). For example, ISI would suggest limits on importing capital goods from abroad, while an FDI strategy may require allowing an MNC to import capital goods from their supply chain.

The success of South East Asian countries in industrialising is often cited as strong evidence for the benefits of following FDI based strategies. This was to an extent dispelled by the South East Asian Crisis in the late 1990s. There was a boom in FDI in South East Asia in the early 1990s, largely based around countries committing to policies suggest by the Washington Consensus such as financial liberalization. Indonesia is a prominent example of successful industrialisation since the “New Order” market reforms enacted by the Suharto regime in the 1970s (Blalock & Gertler, 2008). Notably the economy went from strong capital controls to complete financial and trade liberalization. One issue with this transition was that industrialisation varied substantially by region, as seen in the value added by region map of Indonesia (Blalock & Gertler, 2008).


FDI leading up to the crisis had led to substantial welfare and productivity gains alongside a surge in industrialisation with some estimates of productivity gains around 2%. Critically, the conditions which allowed for successful industrialisation through FDI contributed to the crisis in South East Asia. Financial market liberalization and the relaxation of capital controls led to huge capital reversals, and critically for Indonesia much of their borrowing was in dollars due to linkages with various MNCs. When the Rupiah came under speculative attacks its devaluation had substantially increased the effective debt burden. Indonesia lost approximately 13.5% of its GDP in 1998 (Aswicahyono, 2010). This had long lasting effect on growth and industrialisation with evidence suggesting that there was fewer small firms’ upscaling production, and output growth depended on existing firms which had benefitted from the initial period of positive FDI (Aswicahyono, 2010).

FDI is an undeniably effective largely market based approach in encouraging industrialisation in developing economies. The incidence of positive spill-overs emphasises the power of foreign investment provided there is the transfer of technology, and operational skills. However, it has been argued that FDI is only one element of achieving successful industrialisation. This is because of certain threshold conditions which must be met in order enable useful FDI, and ensure that local firms have an absorptive capacity of new technology and skills. These limitations are well evidenced with the Sub-Saharan experience with FDI and limited industrialisation. There are dangers to FDI being used as the ultimate solution as at times some capital controls are important for economic protection, the experience of many South East Asian economies is testament to this. Currently, the case for FDI is a direct strategy for achieving industrialisation remains ambiguous noting the failure of some globalization related policies.

A. ADIR 2017


Aswicahyono, H. (2010). Industrialisation after a Deep Economic Crisis: Indonesia. The Journal of Development Studies, 46(10), 1084-1108.

Blalock, G., & Gertler, P. J. (2008). Welfare Gains from FDI Through Technology Transfer to Local Suppliers. Journal of International Economics, 402-421.

Calvo, G. A., Leiderman, L., & Reinhart, C. M. (1996). Inflows of Capital to Developing Countries in the 1990s. The Journal of Economics Perspectives, 123-139.

de Mello, L. R. (1999). Foreign Direct Investment Led Growth: Evidence from Time Series and Panel Data. Oxford Economic Papers, 133-151.

Rodrik, D., & Subramanian, A. (2009). Why Did Financial Globalization Disappoint. IMF Staff Papers, 56(1), 112-138.

te Velde, D. W. (2001). Foreign Direct Investment for Development: Policy Challenges for Sub-Saharan African Countries. London: Overseas Development Institute.

[1] This is not an exhaustive list of perceived baseline requirements for FDI, rather an emphasis on key factors.

Higher Education Green Paper

It has been an extremely busy past week. Between the release of the Higher Education Green Paper and the Autumn statement the political system is in top gear just before the holiday season. While we are also quietly creeping towards an inevitable vote for airstrikes in Syria. So I am going to look at part 1 of this past week which is the Green Paper. I have no choice but to be interested in this really as I am a student in university, so I feel it is an obligation (some reason I highly doubt most other students will sift through the document, but rather attach themselves to the headlines and staunch opinions).

Firstly, this paper was undeniably needed, student satisfaction and fees has been a volatile issue prompting the need to provide a new look. The OECD just came out with figures suggesting on average the fees at U.K. universities are higher than those of the U.S. With this particular headline just being more fuel to a fire of sensationalism around the issue of fees. It has to be appreciated that while paying £9,000 a year an individual has access to the preeminent British institutions of education such as Oxford, Cambridge, and the rest of the Russell Group. While in the United States at a typical Ivy League university take Yale for example you pay £30,000 a year, as a domestic student. Admittedly both countries take advantage of you when you are an international student (good I got my British citizenship before I went to university).

The first part addresses teaching excellence and quality. The main concept behind this is that students will m0ve towards identifying their university of choice based upon the teaching rather than the reputation. On this basis this is a good idea, pushing forward the teaching excellence framework (TEF). However, it is the following part in the paper which is of concern. Increasing levels of the TEF would enable universities to increase tuition fees. Now the inequality that may create is relatively clear, my biggest concern is what the benchmark for performance is. The top universities in the UK all already charge the full £9,000. If the university performs well with TEF could they then charge across the board higher tuition fees for all their course? In which case could someone justify paying something like £15,000 for an English degree knowing the average salary that such a degree leads to in terms of a career after university?

Supposedly a newly formed Office for Students is meant to overlook that targets are set sufficiently high, and to bring into enforcement the desired goals. There is also the inclusion of needing “widening participation”. Yet I am always cautious of such friendly phrases such as widening participation. On an initial view it looks like a firm trying to maximise profits. Perform well on a set criteria that students might not actually have such a powerful say in, have higher fees, bring in as many students as possible, and then profit. Now obviously this is a considerable simplification with undeniably a skeptic’s view. However, there is an issue to address here and one of those is the longevity of universities in a sense they cannot be subject to the current whims or social leanings of a new set of students every year, as well as the challenge of managing expectations.

Regardless of its perceived shortcomings it is a step in the right direction, realising that students are paying for a service and there must be quality in that.

The following section was with regard to the education sector as a whole. Namely the idea to enable the creation of a universities in that rewarding institutions with degree awarding powers. An example is A.C. Grayling’s New College of The Humanities, which while a full education institute can only award degrees through the University of London external program. The idea here is to bring more competition in the market, and undoubtedly to challenge the institutions which have been comfortable with their awarding powers up until now.

This sector is going to become more dynamic and less antiquated which I believe is the main goal. While not agreeing with every notion in the paper, I feel it was an important step towards improving the industry as a whole. I am unsure of the impact it has on those in research roles and the funding they may get, so I will look into that further.

Education is always a complex issue, with teaching quality being quite a precarious variable to measure. Personally I have felt that the larger issue amongst U.K. universities is that of spirit. Compared to the U.S. counterparts a large part of student satisfaction is derived from the university identity, sports, music, and other inclusive events. It will always be a hard sell when the product is a two hour lecture on statistical theory even with the greatest teaching quality, so this is just another area to consider.

Between Debt and The Devil – Adair Turner

Adair Turner recently came to speak in the Bristol Festival of Ideas. With his talk being centred around the ideas he explores in his new book “Between Debt and The Devil: Money, Credit, and Fixing Global Finance”

You can find the recording of his entire talk in the link below, as well as an interview done with him which is particularly interesting:

He highlighted some feasible ideas, and some less so, but overall it was fascinating to see the opinions of someone who was in a position of considerable authority post crisis as he was the chairman of the Financial Services Authority. Below I have highlighted parts of his talk:

Turner outlined two main problems which he believes are facing modern economies

Problem 1

Rising Inequality

  • Problem of secular stagnation
    • Savings of the rich are too high (MPC too low)
    • Capital saturation especially in the US
    • Stagnated Wages
  • Specifically applied to the United States
    • Trickle down economics was invalid
    • Credit was the aspect of the subprime mortgage boom
    • People with low wages were finally able to access credit for toxic assets

The Role of Real Estate

  • Fundamentally ignored by Economics
    • Safe and over credit intensive
  • Turner highlighted that we need to address the credit intensiveness of our economies
    • Namely with suggesting that bank capital ratios should be around 20% rather than 4-5% if progress it to be made in this area.

Global Balance of Payment Imbalances

  • Surpluses are driven fundamentally by credit

Problem 2

“We have run out of ammunition to stimulate our economies”

  • Fall back of the central bank printing money to drive forward inflation and bump the economy
    • Severe deflationary trap can always be solved by helicopter money
      • Certain circumstances which can get us out of this trap
      • Not necessarily producing hyperinflation (smart printing)
    • The problems here are fundamentally political
      • Taboo of Money Finance amongst politicians
        • Once they realise its possible, what will stop them from doing it further
          • Suggesting political policy to moderate such a tool
        • Japan and Eurozone specifically need this
      • Between Debt and the Devil

Two ways to ensure expenditure in aggregate nominal demand

  • Print and Government Spending (Devil)
  • Private financial system to push through purchasing power rejuvenation
    • The free market in this case led to the extreme inequality
    • Markets fail and run out of control, and they were let free and not cared for
  • Choosing between alternative risks – private debt or government irresponsibility

The skeptic in me suggests that most of his proposed ideas were book selling ideas, but there is a valid discussion around the use of helicopter money, and our increasing lack of ability to dictate our economies when needed. We seem to be vehement supporters of free market economies, but then become increasingly frustrated when our targets of growth or inflation are not reached. So if this is to be the case it is clear we need to make some compromises in these areas, namely addressing economic literature and bringing it into use rather than going back to conventional heterodox policy and the shortcomings which have become frequently apparent.

One little area that annoyed me was his reference to how something like tax rebates would work in regards to spurring aggregate nominal demand, as a method of overt monetary finance. As it has been conclusively shown that consumers will not directly translate this into spending, and if so it is purely transitory and has no long run permanent effects. There is some merit in other examples he used of potentially using overt money financing such as introducing large infrastructural programmes. This has often been a go to idea though for trying to prompt long term growth, not saying that it is a bad one but we tend to mismanage our ability to commit to long term projects.

More to come this week, the next post on ‘Corbynomics’ and nationalisation.







Corbynomics – Nationalisation Part 1

A truly disastrous title, I will never really understand the need to try and produce catchy names out of policy ideas. Regardless, it is not even really Corbynomics because these ideas have not come from his flat in North Islington.

So we are going to start with re-nationalisation of the Gas and Rail industries. It is important from the onset to appreciate that these are two very different industries, and consequently pose different problems in regards to how they may be nationalised. This post will start with rail.

The form of privatisation that took place in the rail industry is by no means conventional. At the moment Network Rail is the owner of infrastructural assets such as the rails, signals, stations, etc. and this company is government owned. While the operation of these railway lines is effectively sub contracted to single companies, with a distinction between rolling stock operation companies and train operating companies.

To simply understand the current system we may view it as something alike to the franchise model, the Office of Rail Passenger Franchising puts to tender contracts to operate portions of rail network, which are then bid for by private companies. Nationalisation would see the government take back all of these contracts into a government owned company resembling what was initially British Rail.

From various research reports and analysis, the current privatised system does not have such clear benefits compared to a government owned system. From an initial look one would note that anyways the government already heavily subsidises the industry with taxpayer money, for passengers to only then be victim to at times predatory pricing.

The theory behind a strong and dynamic competitive market to produce the best outcome for customers and firms is valid, but I would hardly call the rail industry an example of complete privatisation. If one was go to a train station now in a non-central city, they will find that they actually only have one company which they can choose to travel with. So where is the competition? Well the answer is that it is meant to be in the bidding process for the contracts, but it’s hard to see how that translates into direct benefits for the customer.

Even more frustratingly these companies take government subsidies, but still produce convenient profits to then dish out in the form of bonuses for their staff. Of which in some cases is going abroad as these companies are owned by European rail companies simply operating through subsidiaries in the UK examples being SNCF and Deutsche Bahn. Not to mention the lack of transparency in the bidding process itself. So in the best of cases it is unclear where the competition is coming from, and why this type of competition would lead to consumer benefits. Passengers can still be held hostage by the train driver unions as seen during the First Great Western strike earlier this year.

The two main problems people have are overcrowding and being priced out. Would bringing it back into government ownership solve these problems? Well at the moment it is clear the private system currently running is not solving them. Not forgetting to mention there have not been vast improvements in the rolling stock either (a promise that modern technology in trains would be a common sight in privatised rail), South West trains still don’t have air conditioned carriages or even Wifi.

The system clearly needs change. In my opinion it all needs to be in government ownership, or to find a manner in which to privatise everything but have dynamic and progressive competition. I agree here with Corbyn (which is rare) that this area needs serious reevaluation.

The below section is effectively price frustration that is simply extension to the problem (accurate at the time of checking):

If I book a ticket one month in advance for London Kings Cross to Manchester Piccadilly on a Monday at 7:40 the ticket costs £113. Lets hypothesise I have to take this hour in order to get to a meeting, and I don’t want to sacrifice weekend (even then one would need to a book a night in a hotel then, which in itself is not a cheap affair). One may argue that this is an accurate cost representing the time and nature of the trip, the main issue is that I don’t have any other choice but to go with Virgin. That is unless I went from Kings Cross to Birmingham New Street, and then to Manchester which I get to pay £92 instead. Any decent European would be shocked people pay these prices for rail travel, especially seeing that the government is already subsidising it…

The Future of Obamacare

Well to some extent it has, regardless of how small a step, it was a step to greater equality in the United States. I am not necessarily the firmest believer in government intervention in regards to healthcare, but equally the position American citizens are put in due to the corporate greed and lobbying power of pharmaceutical and insurance companies is an equal evil.

The Patient Protection and Affordable Care act did not go as far as Obama had wanted it to go. However, it has allowed millions of American cover that they otherwise would not have. One would hope that in the worlds super power economy, people do not have to make a tough decision between putting food on the table for the family or having health insurance.

Moreover, it did not lead to the fears of its opposition, as the cost of healthcare in real terms has not increased. The fear now however is that any foundation laid by the act will be undone by the future policy of the Obama administration, in that the specific protection for the Pharmaceutical lobby.

Stiglitz has pointed out the case of how India was forced to take up patent law in 2005, due to the competition Indian pharmaceutical companies were bringing to drug production, and in that the western pharmaceutical lobby’s fears that competition from the generic market. In the 1970s India abolished pharmaceutical patents, and this lead to an industry, which would be capable of providing some degree of healthcare in the developing world.

The Obama administration is seeking a bi-lateral trade deal with India that will ultimately secure the position of the pharmaceutical companies. Critically, along with Obamacare, it is clear that there needs to be an overriding framework that ensures that care and medicine is affordable. Stiglitz argues that this is not an unintentional outcome of the trade deal, but rather an explicit element of US trade policy. Thus, we come back sadly to a trade off between the US and its desire to keep domestic jobs, and protect a well-lobbied industry.

The argument that the rigorous American patent system is ensuring profits for innovation and development is becoming worn out. Stiglitz gives the example of Hepatitis-C treatment, which in India goes for $1,000 per treatment with profitability, but in the U.S. for $84,000. This chasm in prices shows the degree of monopoly power that the U.S. government grants in the healthcare industry, and this bi-lateral trade agreement will only reinforce this if India strengthens its patent laws.

So it is increasingly clear that healthcare in the United States can be approached from a more critical angle, rather than still trying to force an act through that lobbyists call communist, but your rational person would call equitable.