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Wednesday, 26 May 2010

FDI and Governance

Increased foreign direct investment (FDI) in Zambia is often banded about by politicians as an endorsement of their politics. What are we to make of this ?

It is certainly true that more democratic systems should provide enabling conditions for increased FDI.  Countries which are more democratic have resilient sets of institutions that allows rule of law to prevail, of which a critical feature (under broader definitions of rule of law) is separation of powers between the Executive and Judiciary. This usually allows the judiciary to hold the power of the Executive in check thereby fostering better rights protection, contract enforcement and so forth. [Although we should not here that the literature between improvement in rule of law and FDI is still subject to enormous debate, largely due to methodological and data problems]. Related to this is that democracy may reduce the associated "political risk" of a mild authoritarian regimes coming into power and seizing all the foreign assets or abrogating existing contracts. Stable transition of power, all things being equal should lead to better enforcement of contracts and a general enabling condition for foreign investment. That of course depends on how genuinely democratic the country is. As I have noted in previous comments this threat of overturning contracts is only limited where the level of democracy is truly embedded through deeper consensual politics - where agreements between government and foreign corporations are truly transparent and have cross party support. Something lacking in
many African countries including our own. However, in general the above suggests that there are good reasons, not necessarily empirical proven, to believe truly democratic societies should lead greater FDI.

Unfortunately, FDI can also thrive in authoritarian regimes. This is mainly because of the strong likelihood of an authoritarian regime being more corrupt due to reduced checks and balance. Investors are usually attracted to such corrupt regimes because it may lower their "transaction costs" e.g. in form avoiding paying high taxes. The extent to which this is a strong incentive depends on the origin of foreign investments. One expects for example investment from non-OECD countries to find this attractive, especially when competiting for investment with OECD countries.  OECD has a strong line on bribery and quite good with its surveillance. This has actually been the argument regarding the mining companies, especially when such investments come from regimes with less than a coherent position on rule of law, etc.  The other reason for the potential for positive correlation between FDI and authoritarianism is that authoritarians may be associated with more stable set of policies relative to democratic competitive regimes. For many foreign investors predictability of policies is more important than nature of investment policy (e.g. the level of tax may be less of the problem compared to the predictability of the tax). So by virtual of the party having a hold on power for decades, one expects foreign investors to be attracted to such arrangements due to the stability it brings. Of course it is a matter of debate on whether there's anything predictable about autocratic cabals!

So in answer to the question : "what are we to make of this ?".  No very much. We should not pay too much attention to those that use FDI as an endorsement of their democratic credentials. It may be a strong signal of their "economic policies", but it does not tell us anything certain about how well they are governing our people.

2 comments:

  1. I like the comment- However, I wish the issue of governance could be seen in such a limited field. I have not seen in your blog the analysis of the effect of external factors on governance. That is corruption and authoritarian governments generate substantial investment if they play to the tune of foriegn governments.

    ReplyDelete
  2. Thembi,

    I thought that point is made, but perhaps not as explicit! That is exactly what this is saying :

    The extent to which this is a strong incentive depends on the origin of foreign investments. One expects for example investment from non-OECD countries to find this attractive, especially when competiting for investment with OECD countries. OECD has a strong line on bribery and quite good with its surveillance. This has actually been the argument regarding the mining companies, especially when such investments come from regimes with less than a coherent position on rule of law, etc.

    But I guess it could have been plainer. I'll try and be more clear next time.

    Thanks!!

    ReplyDelete

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