29-2 Singh.pmd - College of the Holy Cross

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206 EASTERN ECONOMIC JOURNAL Aizenman reaches a broadly similar conclusion: “…..there is solid evidence that financial opening increases the chance of financial crisis. There is more tenuous evidence that financial opening contributes positively to long-run growth” [2002, 2] However, from the perspective of economic policy an important consideration is how to proceed from the short to the long term. The economic crises, and the instability that capital account liberalization is seen to generate in the short term, may compromise a country’s future economic development by inducing capital flight and lowering domestic investment and long-term economic growth. In summary, in view of these facts and analyses, Stiglitz [2000] is fully justified in castigating the IMF for promoting universal capital account liberalization when most developing countries were not ready for such policies. Fortunately, in the wake of the Asian crisis the IMF has in the most recent period moderated its stance in this respect. CAPITAL ACCOUNT LIBERALIZATION AND FDI 14 As explained in the introduction, while Stiglitz finds a “compelling” case against any general liberalization of the capital account, he also suggests that there is a “compelling” case in favor of FDI. In view of the fickleness of the short-term capital flows and the gyrations of the markets, he comprehensively rejects the argument that capital account liberalization is desirable because it imposes discipline on countries by forcing them to follow good economic policy. However, he states that “far more relevant for the long run success of the economy is the foreign direct investment and the desire to acquire and sustain FDI provide strong discipline on the economy and the political process “ [ibid., 1080]. Although he does not specifically address this issue, Stiglitz comes close to accepting the principles of the new proposal that is being put forward by the EU and Japan at the WTO for a multilateral agreement on investment (hereafter PMAI), covering only FDI. The background to this proposal is as follows. Three years ago the OECD countries failed to negotiate a Multilateral Agreement on Investment (MAI) among themselves, which was intended to be acceded to later by developing countries. PMAI is similar to MAI with the critical difference that, unlike the latter, the former will only be confined to FDI. This clearly represents a significant concession to developing countries. The advanced countries’ preference would seem to be to establish a binding treaty at the WTO that would create a regime for FDI similar to that of (free) trade in goods. Since this agreement would be based on WTO’s basic concepts, previous history suggests that it is likely to include the following kinds of elements: the right of establishment for foreign investors (the concept of market access); the principle of most-favored nation treatment; the principle of national treatment; investment protection, including matters relating to expropriation and the transfer of capital; additional disciplines relating to, among other matters, entry, stay, and work of key personnel; prohibition of performance requirements on foreign investors;
CAPITAL ACCOUNT LIBERALIZATION 207 rules on investment incentives; binding rules for settling disputes through the WTO dispute settlements mechanism. 15 In favoring FDI Stiglitz seems to be a part of a general consensus among economists that suggests that compared with debt and portfolio investment, FDI, apart from its other merits, is the safest source of funds for developing countries. It neither adds to a country’s debt, nor (being bricks and mortar) can it be quickly withdrawn from the country. Further, in view of the other virtues of FDI in bringing new technology, organizational methods, and, importantly, spillovers to domestic industry, its proponents claim that the case for PMAI becomes overwhelming. Those propositions will be contested below and it will be argued that unfettered FDI is not in the best interests of many developing countries. As with short-term flows, FDI also requires appropriate regulation by these countries to enhance social welfare. Because such measures would be denied by PMAI, poor countries should resist the proposed agreement. I begin this analysis by noting that developing countries’ perspective on, and attitude towards, FDI has changed. In the 1950s and 1960s, developing countries were often hostile towards multinational investment and sought to control multinational companies’ activities through domestic and international regulations. During the last two decades, however, emerging countries have been falling over themselves to attract as much multinational investment as possible. This enormous shift in developing countries’ stance toward multinational investment is associated with major changes that have occurred in the pattern of international capital flows to developing counties. The former may be regarded as both a cause and a consequence of the latter. The most important change in capital flows for the purpose of this paper is the emergence of FDI as a predominant source of external finance for developing countries during the 1990s. Between 1996 and 1998 FDI inflows to developing countries constituted about 10 percent of their gross capital formation. [Singh, 2001; UNCTAD, 2001]. It is also important to note that alongside these changes in the pattern of external finance, analysis and evidence suggest that developing countries’ need for external finance has greatly increased. This is in part due to the liberalization of trade and capital flows in the international economy. UNCTAD [2000] suggests that because of these structural factors, developing countries have become more balance-of-payments constrained than before: the constraint begins to bite at a much slower growth rate than was the case previously in the 1970s and 1980s. In these circumstances it is not surprising that developing countries have radically changed their attitude towards FDI. These counties, therefore, have competed intensely to attract FDI. This competition has resulted in a shift in the balance of power towards multinationals. An important objection to PMAI is that if approved, it would worsen this imbalance because the Agreement would essentially give the multinationals a license to (or not to) invest wherever or whenever they like regardless of the circumstance and needs of developing countries.
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29-2 Singh.pmd - College of the Holy Cross

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