Kidron on Pearson on private foreign investment: debunking the myths

Editor’s introduction

I was going to open by writing that Michael Kidron (1930-2003) is best known as a Marxist economist, a leading theoretician of the International Socialist (IS) tradition and the foremost developer of the theory of the permanent arms economy as the means to explain the post-war economy. On the other hand, it then occurred that he is also remarkably well known as a cartographer, particularly through the State of the World Atlas series and associated volumes published in many editions by Pluto Press. Then again, Mike was first and foremost a development economist—and an influential one at that. His most famous book in that field, Foreign Investments in India, was first published in 1965, and any search of the internet will show an inordinate number of references to that book. Indeed, the book was republished in its entirety in 2000 by Routledge as the second volume in their influential multi-volume series The Hegemony of International Business 1945-1970.

Why this digression? Primarily because, on the left in general but also within the International Socialist tradition, Mike’s work in the field of development economics has been largely overlooked—even though it has important lessons, particularly in the study of the changing face of imperialism. Of course, there are notable exceptions to any general rule. Nigel Harris has been a long term and consistent advocate of Mike’s work in the field. In his essay “All Praise War!”, published in International Socialism 102 (spring 2004), Nigel treats us to a brief excursion into IS history and writes:

Kidron set out to understand why world capitalism, characterised before the Second World War as apparently in permanent stagnation (in Trotsky’s 1938 Transitional Programme, the epoch was one of war and mass unemployment) was, in the 1950s, expanding with unprecedented speed (and far from mass unemployment, was sucking workers in from the rest of the world). His answer turned upon unprecedented levels of peace-time arms spending, lowering the organic composition of capital and thus offsetting the tendency of the rate of profit to fall, a thesis later absorbed into his idea of permanent waste in the system.

However, more important in my view was his analysis of foreign investment in India and the transition from the old order of capitalism, imperialism (identified in his last unpublished manuscript as “middle capitalism”, between the primitive accumulation phase and the present order), with a built-in competitive drive to the expropriation and incorporation of territory. By 1960, that drive had largely gone into reverse and decolonisation was all the rage. In his work on India he identified—in my view, with remarkable prescience—the transition to a post-imperial order, “world capitalism”. He showed that much of what we identified as essentially capitalist—for example, the size of firm and its relationship to the state—was in fact only a feature of the old order. In the new order that was emerging, he found what we were to describe a decade or more later as “multinational corporations”, which did not depend on any one state but related to many states.

Along the way Nigel has been successful in championing Mike’s development economics work to others. In his 2009 book Imperialism and Global Political Economy, Alex Callinicos wrote in reference to Mike’s Foreign Investments in India, “I am grateful to Nigel Harris for impressing on me the importance of this study.”

Cutting now to the chase—when I was working on the Bibliography of the Writings of Michael Kidron (available at www.marxists.org/archive/kidron/bio/bibliography.pdf) I was fortunate to be able to track down a previously unpublished paper written by Mike with his “development economics hat” on. Before presenting the paper itself, it is appropriate, given it was written in the 1969-70 period, for me to provide some information to give a little background and context.

Finding the Paper

It is worth recounting how an important paper by Kidron could be hiding in plain sight for over 50 years and how it was found. Harris was again the, in this case unwitting, catalyst.

I was re-reading Nigel’s famous essay “Imperialism Today” that was first published in 1971 by Hutchinson of London in the compilation of major IS writings titled World Crisis: Essays in Revolutionary Socialism. The essay was republished in the 2017 Selected Essays of Nigel Harris: From National Liberation to Globalisation. In the essay Nigel uses two quotes that are referenced as: “Kidron, Michael. 1969. Pearson on Foreign Investment. Unpublished paper.”

Simultaneously to working on Kidron’s bibliography, I had been doing a large amount of research into his life and politics. From this I was aware that, from 15 to 21 February 1970, Mike had attended a large, prestigious conference called by Colombia University. Much of the output of the conference was captured in a book titled The Widening Gap: Development in the 1970s. The “foreword” to that book outlines the background:

In February 1970, Columbia University called a conference on international economic development in response to the recommendations put forward in Partners in Development, a report prepared for the international community at the invitation of the World Bank. This report had been drawn up the previous year by a distinguished commission of experts, chaired by The Right Honourable Lester B Pearson, and has come to be known as the Pearson Report.

It was not a great leap on my part to appreciate that Mike’s paper “Pearson on Foreign Investment” was almost certainly connected to the Pearson Report and also, most likely, to the conference.

Unfortunately, Mike’s paper does not appear in The Widening Gap, although his participation in the conference is confirmed on page 349 as: “Michael Kidron, Yale University Pakistan Project, Pakistan Institute of Development Economics”.

More detective work followed until I discovered that a copy of Mike’s paper, which was actually now titled “Pearson on Private Foreign Investment”, was stored at the Foreign Affairs Research Documentation Center, Office of External Research, US Department of State along with the other papers presented at the conference. Our good friends at the University of London Senate House Library stepped up to the plate and managed to access a copy of Mike’s paper, which they discovered was also held at the University of Michigan.

The Pearson Report

In October 1967 the then president of the World Bank, George Woods, first suggested a “grand assize” in which an international group “of stature and experience would meet together, study the consequences of 20 years of development assistance, assess the results, clarify the errors and propose the policies that will work better in the future.” Later, in August 1968, the new president of the World Bank, Robert S McNamara, asked Lester B Pearson, former prime minister of Canada and Nobel Peace Prize winner, to form a Commission to undertake such a study. Three months later, the Commission on International Development held its first meeting in Mont Gabriel, Canada. With Lester Pearson as its chairman, it comprised seven prominent international figures: Sir Edward Boyle (Britain), Roberto de Oliveira Campos (Brazil), C. Douglas Dillon (US), Wilfried Guth (Federal Republic of Germany), Sir Arthur Lewis (Jamaica), Robert E Marjolin (France) and Saburo Okita (Japan). After 11 months of intensive investigations, including meetings in Latin America, Africa, Asia and the Middle East, at which some 70 governments presented their views, the Commission drew up its findings and recommendations in a 400-page report titled Partners in Development.

A quick look at the CVs of the members of the Commission, a collection of businessmen, professional diplomats, politicians and economists (none from the left) as well as the sponsoring organisation, tells you all you need to know about the true purpose of the enterprise—making capitalism work, East and West, and North and South.

As reported in the February 1970 issue of the UNESCO Courier, the following are the 30 major goals and recommendations of the Pearson Commission Report:

IN THE FIELD OF TRADE

Vigorous expansion of world trade is needed for rapid international development, with developing countries becoming more outward-looking and competitive.

Developed countries should abolish import duties and excessive excise taxes on primary commodities produced exclusively by the developing nations.

Developing countries should be assured of an increasing share of markets for their agricultural products which may also be produced in the developed countries.

Financing should be available to help poor countries meet shortfalls in export earnings.

Quantitative restrictions on manufactured imports from developing countries should be abolished during the 1970s. Trade between the developing countries themselves must be greatly expanded, partly through new mutual tariff concession agreements.

Regional development banks should be more strongly supported, and they should extend export credits to developing countries.

International organisations should study the need for international payments arrangements to facilitate trade among developing countries, and they should negotiate mutual and wide-ranging tariff concessions.

Financial support is needed for stores of agricultural products to meet periods of lean years and to stabilise prices.

FOREIGN INVESTMENT

Developing countries should remove impediments to foreign investment and assure stability and improved administrative procedures affecting foreign firms.

Foreign investors in developing countries should contribute to manpower training, local industry and national growth.

Developing countries should not grant foreign investors excessive protection and tax concessions.

International organisations and creditor governments should set up an “early warning system” to let developing countries know they are nearing the danger zone of excessive debt burden.

Private foreign investment is not an alternative to public aid. Official aid to finance roads, schools and hospitals is a prerequisite to private investment.

ECONOMIC GROWTH

Increases in aid should be clearly aimed at helping the developing countries to reach a path of sustained growth. The target of the 1970s is to increase average annual GNP by at least 6 percent per year. Countries that reach this level should be self-reliant by the end of the century.

Aid increases in the future should be closely linked to the economic objectives and development performance of the countries receiving aid. In return, poor countries should expect commitments of support from rich countries.

VOLUME OF AID

The UN target of foreign aid by wealthier nations equaling 1 percent of their gross national product should be reached by 1975 at the latest. Public or government aid in the form of grants or low-interest or interest-free loans should make up 0.7 percent of the gross national product by 1975 and in no case later than 1980.

Food aid programmes will have to be replaced by other forms of aid as developing countries become more self-reliant in food production.

DEBT RELIEF

Debt relief should be recognised as a legitimate form of aid. To avoid future debt crises, aid terms should be more lenient and uniform among donor groups.

AID ADMINISTRATION

Foreign aid donors and receiving countries should meet this year to cut through administrative red tape and set up three-year programmes instead of annual budgets.

There should be less strings attached to aid-giving obliging developing countries to buy goods in donor countries. Donor nations should grant more leeway allowing their funds to be used for buying in other developing countries.

TECHNICAL ASSISTANCE

Rapid growth during the 1960s of more than 10 percent a year has created shortcomings in this form of aid. It has often failed to meet the actual requirements of developing countries, especially in agriculture and education, and has not been adequately integrated with capital assistance.

National and international corps of technical assistants should be able to make a career of their work, with help from both donor countries and private institutions.

POPULATION CONTROL

Family planning should be available to all. No child should be born unwanted. Birth rate control must be stressed by both donors and recipients when planning aid programmes.

A Commissioner for Population should be appointed by the UN to help direct population control programmes in the various UN agencies.

The World Bank in consultation with the World Health Organisation should launch an international programme for the mobilisation of research resources in this field.

AID TO EDUCATION AND RESEARCH

Greater resources should be made available for educational research and experimentation in new teaching methods in developing countries to increase their capacity to absorb, adapt and develop scientific and technical knowledge.

A share of research and development resources in industrialised countries should be oriented towards problems in developing countries. Rich countries should help in setting up international and regional centres for research and development in fields such as tropical agriculture, extension techniques, education and urban planning.

MULTI-LATERAL AID

International organisations must exert greater leadership and direction to make development assistance a genuinely international effort.

The share of multilateral aid should be increased from the present 10 percent of official public aid to 20 percent by 1975. The International Development Association (IDA), the World Bank’s easy-loan financing agency, should become a pivotal organisation in multilateral aid efforts.

IDA should almost quadruple its work by 1975 with national contributions reaching a total of $1,500 million, compared with a level of $400 million at present. Regional development banks must also receive increased support.

The president of the World Bank should call a conference during 1970 of all UN and other international, multilateral and bilateral agencies to work toward coordinating their efforts, now lacking direction, so as to create a coherent international aid system.

In fact, the report contained a total of 68 specific recommendations. The Widening Gap book states, “These recommendations cover the four broad categories examined in this volume: proposals for an accelerated rate of growth for the developing world as a whole; proposals for the liberalisation of trade among the developing countries themselves, and between the developed and developing areas of the world; proposals for new attitudes toward private investment; and proposals for a complete rethinking of the aid relationship.”

Mike’s Paper and the Conference

Mike’s paper, “Pearson on Private Foreign Investment”, is, as its title suggests, concerned with that part of the Pearson Report dealing with foreign investment—an area in which Mike had specialised for much of his academic career. For that reason it is worth recording in full the ten lower level recommendations of the Pearson Report as they relate to Private Foreign Investment and as they are stated on page 123 of the report. They are:

1. Developing countries should take immediate steps, where consistent with legitimate national objectives, to identify and remove disincentives to domestic private investment.

2. Developing countries should preserve the greatest possible stability in their laws and regulations affecting foreign investment.

3. Developing countries should strengthen their investment incentive schemes wherever possible.

4. Developing countries should structure their tax systems so as to encourage profit reinvestment by foreign companies.

5. Because the IFC and organisations like it have links with the private sectors of both developed and developing countries, they are logical agents for project identification and investment promotion work, and they should become much more active in this field.

6. Governments of developing countries which attach great value to domestic ownership of industry should establish positive incentives for all companies, foreign and domestic, to share ownership with the public by sale of equity in suitable forms.

7. International institutions, such as the World Bank and UNIDO, should expand further their advisory role regarding industrial and foreign investment policies.

8. Developed countries should remove legal and other barriers to the purchase by institutional investors of bonds issued or guaranteed by governments of developing countries.

9. Developed countries should remove balance-of-payments restrictions presently inhibiting the bond issues of developing countries in international capital markets.

10. In regard to the possible excessive use of export credits, a strong “early warning system” based on external debt reporting should be evolved by the OECD and the World Bank.

Mike’s conference paper is Pearson Conference Document No. 28, and Mike will have played an important role in the conference—certainly important enough for him to get a mention in that part of The Widening Gap book that deals with the conference debates on Private Investment.

It seems that whereas Pearson saw benefits of private investment to be substantial the conference was divided. As expounded in The Widening Gap:

The Pearson Report’s proposals raised no difficulty for those who spoke from a background of administration and management of international capital… The central body of opinion at the conference took a more discriminating line. One could call them the “show me” supporters of private investment. They did not deny its capacity to transfer technological skills and stimulate local production. But they did suggest a long hard look at the price tag… Behind virtually all the reservations which found expression in the debates there lay not so much doubts about the economic advantages of private investment as about its social and political drawbacks. Above all, there were doubts in that most sensitive of areas, the post-colonial achievement of sovereignty, where the risk was felt to be loss of independence, loss of control. For this reason, the role of the new multinational corporations as instruments of development was intensely debated…the debate plunged straight back to the centre of the conference’s main division—those who accepted the existing world economy as normal, and those who saw it as neo-colonial, based on domination by the rich and exploitation of the poor…the response of the radical minority, and for them the only sane solution was an end to further private investment, expropriation of existing enterprises, and the creation of local, self-reliant industry with whatever technical assistance can be secured entirely without strings.

Mike’s paper is important on more than one level. On the political front Harold Wilson, the then Labour Prime Minister, was able to describe the report as “one of the most important documents of the 20th century.”

That positive view was held amongst other parts of the supposedly more progressive sections of society as well as some of the decidedly unprogressive. For instance, The Observer newspaper was able to report that “the report is, as it was described by Mr Wilson, one of the most important documents of the 20th century… The prime contribution made by the Lester Pearson committee is that it has expertly clarified the areas of doubt about the effectiveness and value of aid, exposed the weaknesses of certain practices that have been allowed to grow up and emphasised the overriding need for the developed nations to act a little less greedily.”

The Times called it “an historic challenge to both rich and poor countries.” Even The Daily Mail commented that the report pleaded “the moral case powerfully and argues that it is in everyone’s interest that all the world’s resources, human and physical, should be put to the greatest possible use.” Clearly, the report was about bolstering capitalism and not about threatening it!

Mike tackles Pearson’s assumptions about foreign private investment concretely and with hard facts borne of his previous research in India. Rather than expound a political critique or develop the blueprint of an alternative hypothesis, Mike concentrates his fire on debunking some of the myths and false perspectives underlying the Pearson Report. If you like, this is Mike providing the ammunition which enables others to fire the gun—but clearly it was a gun that needed to be fired, both politically and economically.

Mike opens his critique by stating, “If the Pearson assumptions about the nature and effect of foreign private investment in underdeveloped countries are right, so are the prescriptions they support and, ultimately, the targets. But if they are wrong, Pearson is wholly indefensible.”

The three specific Pearson assumptions for the benefits of foreign private investment that Mike tackles are i) a positive balance-of-payment effect ii) a positive development effect iii) a neutral policy effect. As befits a conference paper of this type Mike’s points are expertly put with a fine balance struck between articulating his argument both positively in his own terms and in specific relation to Pearson but also with the provision of hard supporting facts and data.

The Widening Gap book specifically picks up one argument advanced by Mike when challenging Pearson’s first assumption:

Both Paul Streeten and Michael Kidron disputed the indirect benefits postulated in the Pearson Report since such benefits flow from any form of investment, local or foreign, and, in any case, can be assumed only if the foreign investment diverts no local resources from other uses, pulls no potential exports into local processing, and stimulates no otherwise avoidable imports. Specific calculations might show foreign investment to be as likely to increase the problem of foreign exchange as to lighten it—save perhaps in oil states so lacking in other activities that the whole stimulus to larger exports can be attributed to the single major industry.

It is a point from Mike’s argument against Pearson’s second assumption that Nigel Harris picks up in his essay “Imperialism Today”, and it is concerned with “the concentration of technical skill in the advanced countries” where:

Far from facilitating the transfer of know-how, foreign enterprises often make strenuous efforts to limit the life and spread of the technology it does sell… That this is so is due to the almost impregnable foreign monopoly of advanced technology that comes from concentrating research and development in the world’s industrial heartlands—whether East or West, whether under private or public management.

I would like to pick up an important point that Mike makes in arguing against Pearson’s third assumption, and that is on the role of the state—a role that exists but is generally subservient to the power of foreign capital:

Governments, even small ones are not entirely without volition or resources. There are passages in the relations between domestic and foreign business in which conflict replaces collaboration and the state is called upon to exercise an arbitrating or defensive function. There are conflicts between the foreign investors themselves and within the domestic private sector. There is the overriding competition between West and East. All of these add to the host government’s arbitrating functions and even provide it with a measure of material autonomy. The result is that underdeveloped countries—even the most backward—are not as defenceless in dealing with the foreign investor as they have been. They clearly do control, regulate and restrain. But unless they are willing to go the whole hog towards full state capitalism with all that that entails in disrupting present arrangements and in possible open conflict, they do these within the narrow limits set by foreign capital’s low tolerance of interference and its ability—together with its domestic partners—to influence positively government’s own aims and methods.

Finally, of course, in his last two paragraphs Mike draws the bigger picture—it is not just about the detail:

The larger consequences are daunting. They go well beyond a balance-of-payments arithmetic or the perpetuation of technological dependence, or the associated problem of excess imports and excess payment obligations. The real victims of the foreign sector’s substantive extraterritoriality and the lesser immunity it casts on the private sector as a whole are planning, the initiatory role of the state, and with them perhaps, the hope for economic development.

In this light, to propose as Pearson does, “a larger flow of foreign investment” is to condone the continued desperation of the underdeveloped world. That the proposal stems from bad premises rather than bad faith hardly matters.

At the end of the conference a large majority of the attendees, including Mike, signed a statement which is known as The Columbia Declaration. The gist of what seems like something of a compromise is:

“We support many of the Pearson proposals while emphasising that they still fall short of what is required and they ought to be supplemented… We leave this conference with the conviction that nothing is more unrealistic than the apparent realism of those who argue that the Pearson Report is fully adequate or even overambitious in terms of the future prospects.”

Mike’s “Pearson on Private Foreign Investment” paper is reproduced in full below. In the 50 plus years since the piece was written some things have stayed the same—notwithstanding the Pearson Report the question of support to the underdeveloped world remains as unsatisfactory now as it was then. However, much has also changed, not least the forward march of globalisation and the emergence of the likes of China and India as industrial powerhouses. However, this publication is an important addition to our canon of Mike’s writings, showing, as it does, his excellence as a development economist, his influence as an academic and an activist, and most importantly, his continuing analysis of how imperialism was changing in the real world before our very eyes. It is a fine example of the kind of input an academic who is a socialist can endeavour to make. As a conference paper it may serve a different purpose and be written in a different way, but it deserves to be read alongside those other very fine pieces of work by Mike with which it is probably most closely associated. That is, his book Foreign Investments in India (1965) and his three great articles, Imperialism: Highest Stage but One (1962), International Capitalism (1965) and Capitalism: The Latest Stage (1971). When reading the conference paper myself for the first time it brought to my mind one of my favourite Mike Kidron aphorisms, one that he used in 1965 to explain how classical imperialism had changed over recent generations: “Then, it was a matter of exporting capital; now, if it is to succeed—a big ‘if’ in fact—it has to export capitalism.”

John Rudge

Pearson Conference

Document No. 28

 

Columbia University

Conference on International Economic Development

Williamsburg, Va. And New York

February 15—21, 1970

 

PEARSON ON PRIVATE FOREIGN INVESTMENT

By

Michael Kidron

If the Pearson assumptions about the nature and effect of foreign private investment in underdeveloped countries are right, so are the prescriptions they support and, ultimately the targets. But if they are wrong, Pearson is wholly indefensible. In either case they are worth considering, for Pearson has been widely greeted as “one of the most important documents of the twentieth century.1

Assumptions I: a positive balance-of-payments effect

In order to sustain a transfer of foreign exchange, the rate of growth of foreign investment needs to be higher than the combined rates of return on, and of, investments already made. Clearly no such transfer is taking place to backward countries as a whole: foreign investment has been more or less constant in the years covered by Pearson, and profits and repatriations must be assumed to have been positive.2

Pearson explicitly dismisses direct foreign-exchange accountancy of this sort. “It does not make sense,” the Report states, “…to evaluate the balance-of-payment effect of foreign investment…by a simple comparison of capital inflows with profit remittances… The correct way to look at the balance-of-payments effect of foreign investment is to ask what the balance of payments would have been like in its absence” (p101). It is, admittedly, a crude measure. Yet it is not as unconvincing as might appear at first blush, if only by contrast with the alternative offered.

Leaving aside, as echoes of a more positivist age, Pearson’s “would have been” and “correct way to look at” anything, let alone any economic thing, there are two fundamental criticisms to be made of the indirect approach in measuring foreign investment’s balance-of-payments effect. At the level of analysis, it attributes to foreign investment benefits that would accrue to any investment, and assumes without inspection that the former always augments, and never displaces, domestic export-earning capacity.3 At the level of experience it is contradicted by almost everything that has happened in the underdeveloped world over the last twenty years, partial exception being made to the Middle Eastern oil exporters. In other words, even if there were logic in the proposition and backward countries had the time to take the longish view it implies, it is doubtful whether evidence could be mustered to support it.

We might start with exports. It is clear from Pearson that the growth rate of foreign investment in backward countries has been very much greater than that of their exports, including oil, over the last fifteen years or so.4 It is not surprising. Since the second world war the trend in such investment has been towards import-replacement not export promotion. Indeed, despite the enormous weight of oil, the trend has been towards export prevention as a practical compromise between the few internationally-competing manufacturing giants that have emerged at the centre of private capital flows and the many politically-independent states that have formed out of the ruins of empire. Investing countries have consistently refused to open their markets to new manufactures from backward countries;5 and investing firms have as consistently sought to prevent their subsidiaries and associates from exploiting the openings that do exist. If India might be permitted to stand proxy for the underdeveloped world as a whole, slightly over half of all effective, formal, Government-approved collaboration agreements contain restrictive clauses of one sort or another, three-fifths of which relate to exports. Of these, 8 percent enforce a total ban, 33 percent stipulate that permission to export needs to be gained from the foreign party, 52 percent limit the number of countries to which exports may be made, and the rest make exporting conditional on the type or value of the product, and so on.6

On the import side, it is no secret that foreign firms have a strong upward bias, particularly in backward countries, where they act as the major channel for exports from the parent firm.7 There are many reasons for this: they come in, normally, to hold a market that might otherwise slip behind a wall of restrictions, and so tend to favour high import-content, assembly-type operations.8 They often find it more convenient to retain contact with home suppliers or clients than make new ones abroad. A high and sustained level of imports offers unique opportunities for price—hence profit and tax—adjustments on a global scale. It reinforces their de facto extraterritoriality and so strengthens their bargaining position vis-à-vis the host government. It perpetuates long-standing habits.

Such imports are seldom cheap, certainly not as cheap as Pearson suggests. If India is at all typical, materials, components and knowhow supplied by the foreign investor frequently cost the local associate more than the landed price for the final goods which they are meant to displace. Nor are these imports particularly sensitive to local business conditions. Even in the most favourable case—capital goods received as equity investment—dividends paid abroad are found in practice to constitute, with royalties, the first charge on earnings after tax, not the residual Pearson suggests they are.9

There is room for dispute here, and a great deal more room for empirical work. In a sense, however, the outcome is unimportant for the key foreign exchange cost lies in the investments themselves rather than in the detail of their pricing or servicing. Paradoxically underdeveloped countries suffer as much from excess imports of capital and technology10 as from their scarcity.

Foreign investment constitutes a major channel for such excess imports. There are conspiratorial reasons for this: a foreign investor might bump up the “necessary” import content of a project by over-specifying and/or overpricing his contribution in kind in order to establish title to a controlling interest; or in order to scale down apparent profits to a politically-acceptable level.

More important are the economic reasons. Investors often supply unsuitable, therefore expensive, plant and machinery because they have an interest in original and replacement sales; because they are unable to supply—or are ignorant of—what is required in an alien and smaller economic environment; because they are unwilling to jeopardise their relations with local partners who might be devoted to the material or human symbols of modernity; because they are unable or unwilling to forego the advantages of specialisation within the firm and therefore must ensure interchangeability of parts; because, as purveyors of knowhow, they have an interest in divorcing the importing of a technology from imparting it and therefore favour installing complex rather than copyable technique—all of which sustains the further paradox common to most backward countries, that capital and knowhow are simultaneously scarce and underutilised.

Most important of all, however, are the institutional reasons, which derive directly from accepted arrangements and ruling attitudes, and for which the foreign investor is not primarily responsible however much he might benefit from their continuance. There are a number here. One is the strong xenophile prejudice endemic in most backward countries, which values products in descending order of foreign-ness; an imported article is ipso facto preferable to one made locally and commands a higher price; a foreign brand manufactured locally by a foreign firm is better than one made by a domestic firm; and so on down the line to purely domestic enterprise. In a competitive market this is inducement enough to seek foreign links without much regard to cost or technological necessity.

Related is the concentration of immense economic and technological power in large, private, internationally-spread corporations whose presence ensures that output in many industries can expand beyond these firms’ targets—and the dissemination of advanced production knowhow can take place beyond their own sphere of interests—only by recourse to further collaboration agreements, further imports of capital and technology, further charges on exchange reserves, and so on—all of which adds nourishment to the economic and conspiratorial factors already mentioned.

It may well be that costs of this kind are necessary—a tax on backward countries for the general upkeep of the competitive system in its private enterprise variant. But there is nothing to be gained from ignoring their existence, or from obscuring the distinction between the technologically-necessary and the institutionally-determined foreign exchange costs of foreign investments. Analytically the difference is clear. Quantitively it is immense. Historically it has had portentous impact.

Let India once again stand proxy for the rest. In 1951 and 1952, foreign-controlled firms exported 70 percent more than they imported. If 1952 only is taken into account in order to exclude the distorting effects of the Korean War boom, they ran a positive export balance of 42 percent. Within four years the sign had been reversed: for 1956-8 the foreign-controlled sector averaged an annual import surplus of 10 percent.11 By 1964/5-1966/7 the average annual import surplus had grown to 330 percent.12 In terms of the visible balance of trade, foreign investors have plainly compounded, not alleviated, India’s difficulties.

So too with the remaining key items in the foreign sector’s balance of payments: invisibles and direct capital movements. For the period 1948-61, dividends, royalties, etc, paid abroad plus repatriations totalled at the very least Rs 718.4 crores as against gross inflows in cash and in kind of at most Rs 247.1 crores.13 Subsequently, in the period 1962-66, the totals were Rs crores and Rs crores respectively.14

However, for Pearson this is still not indirect enough: “the key question is the productivity of the foreign investments for the economy as a whole.”

Assumptions II: a positive development effect

The Pearson case here rests on three propositions: that “foreign investors can…stimulate local enterprise through increased demand, demonstration effects, and access to foreign technology and business methods”; that “the external economies radiating from foreign investments involve notable improvements in infrastructure and social overhead facilities”; and, albeit with some reserve, that “high profits imply that such [direct foreign] investment is particularly efficient” (p101).

In the absence of offsetting measures, there is—we have seen—good reason to expect the stimulus of demand from foreign investment, particularly for the more complex inputs of modern manufacturing, to be felt abroad to a great extent. Similarly, there is reason to believe that the demonstration effect of advanced foreign technology and business practice would be more likely to operate via expensive replication than through diffusion. None of this might matter much were the host country in fact to enjoy the easy access to foreign technology and practice suggested in the first proposition.

It normally does not. In one or other form, most backward countries find themselves occasional victims of technological boycott. All are denied—for good economic reasons—the stimulus of domestically-located research and development. Most are tied to imports for key elements in a manufacturing process with the common result that they are neither able to adapt production techniques to local resources nor to sit out unnecessary changes in product or method. And many find that key technical and managerial appointments in collaborative ventures remain within the gift of the foreign investor whether or not that investor has majority ownership.

Far from facilitating the transfer of knowhow, foreign enterprise often makes strenuous efforts to limit the life and spread of the technology it does sell. This is done through blanket patent protection—nine-tenths of all registered patents in India and almost all patents in the technology-intensive industries are taken out by, or on behalf of, foreign firms. It is done through restricting the local partners’ right to collaborate with others, to sublicence, to use imparted techniques in new ways without prior agreement. And it is done through setting a fixed term to their use: despite official pressure, more than three-fifths of all collaboration agreements in India do not expressly recognise the Indian party’s right to dispense freely of the knowhow transferred after the expiry of an agreement, while some go as far as to require the return of drawings, specifications and other data supplied.15

It goes without saying that many of the agreements have more teeth in them than bite, and that a great deal of knowhow is in fact transferred. But the intentions are plain and the effect considerable.

That this is so is due to the almost impregnable foreign monopoly of advanced technology that comes from concentrating research and development in the world’s industrial heartlands—whether East or West, whether under private or under public management.

The reasons for such concentration are familiar. Dealing with the private sector only, if there is advantage in specialisation within the large international firm, that advantage is most pronounced in organising technical innovation. Research and development have long ceased to be the inspired achievement of individuals, loosely related to immediate need and unsystematically rewarded. They are a managed, predictable output of teams, based on a ramified, developed educational infrastructure such as can be found only in the developed world. They form an industry in its own right, and one of growing importance as, on one view, “what nations sell in international trade is, to an increasing extent, the ability to innovate quickly”.16 For many firms, particularly amongst the big international investors, they are—as pure technological or managerial knowhow, or as knowhow built into products—the fastest-growing component of sales. It is inconceivable that such firms would see any advantage in fragmenting these crucial technological and managerial functions; or could, even if they would.

The results are as familiar. They embrace the open drain of scarce professional and technical manpower to western industrial countries, exacerbated since the war by competitive uptrading in immigrant-skill requirements and competitive immigrant-source diversification;17 as well as the hidden drain, via employment in resident foreign firms, of local intellectual output, and its annexation by foreign firms as private technological capital and private managerial practice. They embrace the virtual absence in the overwhelming majority of cases of laboratory facilities other than what might be required to analyse local raw materials or test local products.

They go farther. Insofar as knowhow is the product of learning by doing, and modern manufacturing increasingly dependent on the application of goal-oriented research; insofar, too, as backward countries need to compete in manufactures and, therefore, to exploit to the utmost whatever comparative advantage they might be able to uncover by dint of intensive research—the concentration of research and development in the industrial countries and the accompanying drain of innovation capability from the unindustrialised ones, are simply catastrophic to their hopes of development.

These results fly directly in the face of the second Pearson proposition, for if there is one sphere in which foreign investment might be thought to have a unique contribution to make, different in quality to anything that can be expected from domestic investment, it is in the building of a self-renewing infrastructure of skills and technical experience. In reality, the contribution is not apparent. If anything, the direction of flow is perverse, and these crucially-important external economies are created for, not by, the foreign investor.

Under the circumstances there would seem to be little advantage for the host economy even if Pearson’s third proposition were true, if foreign investments were in fact “particularly efficient.” For the spread of that efficiency would be limited, and its cost could turn out greater than the benefits.

How true is it in any case? Pearson itself is unemphatic and conditional—profitability is a good criterion of efficiency “unless it is assumed that [profits] derive from monopoly, or from distorted prices” (p101). And well it might be, for the evidence is at best ambiguous.

True, profit margins for foreign investors are normally greater than they are either at home or for the domestic investor in the host country. Sometimes they are very much greater.18 But it would be unrealistic to infer efficiency from that fact. There are other, equally good, reasons for it in the imperfect markets of the underdeveloped world. Prices of manufactures, particularly in the advanced technology-intensive sectors to which foreign capital flows, inflate rapidly in the decompressed atmosphere provided by most governments, while key inputs—of labour, even after adjusting for lower productivity, of fixed capital, of local finance—are relatively cheap for any of a number of environmental, institutional or policy reasons that in practice confer particular advantage, unrelated to efficiency, to foreign enterprise.

Some costs are higher—physical depreciation, for example, or imported machinery, materials and management. In capital—and technology-intensive industries they often outweigh the cost savings listed. But they would need to be unbelievably high to also outweigh the price differential and so to substantiate the claim of superior efficiency.

Whatever direct evidence there is tends to confirm these deductions. Machine utilisation in foreign firms is more often than not low and breakdowns frequent. This might be due to a bad fit between available materials and the plant supplied; or imperfect maintenance, itself a product of excessive capital- and technology-intensity. It might even reflect the costs of resentment—a product of the frustrations and irresponsibility felt by local technicians who feel themselves to be every bit as good as the foreigners to whom they are subordinated, who might even be better in that they possess less specialised skills and greater sensitivity to local conditions, and yet who earn a fraction of their salary and enjoy an even smaller proportion of their prestige.

Nor could one expect anything different on general grounds. Operating efficiency must be affected by the diseconomics of a ubiquitously small scale, which in turn reflects the discrepancy between the size of the market foreign investors are normally willing to serve and the productivity of the techniques they are geared to use. It also reflects their motives for investing in the first place, namely to reserve that market at almost any price.

If the record is anything to go on, then, we might conclude that foreign investment is unlikely to enrich its host environment spontaneously. Nor, to be fair, does Pearson altogether expect it to. In at least one area, Pearson is quite willing to thwart the natural inclinations of foreign investors: “when monopoly profits are being earned,” runs the Report, “the proper remedy would be to reduce tariffs, take action against specific monopoly practices, renegotiate concession agreements, or initiate competitive enterprises rather than restrict the inflow of foreign capital” (p101).

It is an interesting proposal for not only does it concede something to the critics of competitive enterprises, but it brings into focus Pearson’s third, and most important, underlying assumption.

Assumption III—a neutral policy effect

By investing at all, the foreign firm signifies its acceptance of some duplication in its operations; but it has every inducement to keep that duplication to a minimum. In capital- and technology-intensive industry in particular, it is cheaper to concentrate production at home where key inputs are relatively plentiful. Where this is not feasible politically, some functional specialisation is nonetheless bound to occur; in research and development certainly, in some manufacturing processes almost as surely. This in turn provides a strong inducement to maintaining strict central control over the entire manufacturing process in foreign affiliates, and the decisive say in key technical appointments.

Beyond the economic and technological arguments for wanting to exercise control lie many of the institutional factors that precipitate foreign investments in the first place. Manufacturing abroad creates a problem of the origin of exports. A large firm normally finds it expedient and easier to ship products from its home base than from the host country: exporting knowhow and contacts are to hand; the parent firm is better able than its foreign affiliate to supply credit or to tap public credit facilities; it is more vulnerable to government pressure at home than abroad, and so on.

Exporting is an aspect of a larger balance of payments problem which impinges directly on a firm’s freedom to allocate funds—and staff—as it wishes. So long as the larger problem exists, and so long as its effects can be mitigated by adjusting the form of business operation to the precise, and changing, pattern of exchange control—by substituting loans for equity, for example, or fees for royalties, or commissions for profits or by any other method—there is point in exerting the fullest possible control over foreign affiliates.

Control, particularly such as is implicit in the practical division of labour within a firm internationally, is also a form of insurance against nationalisation or expropriation; it can dispel the uneasiness felt by management when working within a diplomatically-charged atmosphere as might exist between equal partners with different traditions and different extra-mural allegiances; it offers financial advantage to growing firms in the form of consolidated accounts; and much else. In short, the drive to control rests on solid ground both within the firm and in its milieu.

The forms in which it is exercised are implicit in much of the above. Full or majority ownership is still a favourite device. Plurality ownership, carrying the implication of fragmented local ownership and interest, is almost as effective while simultaneously taking into account local pressures and susceptibilities. Probably more important is the control built into the structure of the large foreign firm: its encompassing of an international division of labour, its technical complexity and administrative integration.

There is little a host government can do to contest this control seriously. It might press for “…isation,” only to find the locus of decision-taking displaced abroad more irrevocably than ever. It might discourage majority ownership, and end up with informal controls in its stead. It can bully and cajole, but in reality it cannot invade foreign capital’s sanctuary—its substantive extraterritoriality.

For that rests on an unshakeable a-symmetry of mutual dependence between the typical international investor and the typical backward country. There are very few foreign firms which do not occupy a commanding position in the economies of such countries, particularly in their crucial, modern sectors; yet there are very few such countries in which these firms have more than a negligible interest. It is not altogether surprising. As the world spins away from the traditional exchange between backward primary producers and developed manufacturing countries, investments become increasingly footloose and more evenly spread internationally. More and more firms approximate the pattern presented by, say, Hindustan Lever—among the first five Indian companies in 1962, yet accounting for one fiftieth of the parent firm’s global turnover, net profit, net worth or capital employed.

The a-symmetry goes well beyond the relations between a firm and its host government. No matter how small the firm’s operations they are part of a single fabric woven from the activities of public and international agencies as well as private lending, investing and trading organisations. While each firm might find it relatively easy to withdraw when faced with what it considers to be an unacceptable demand on the part of the host government, that government would have to pay a very heavy price indeed for misjudging the threshold of acceptance shared by the foreign sector as a whole.

There is thus a broad immunity for the foreign sector within which the price and profit adjustments, the inflexible servicing payments, the restraints on the spread of knowhow, the resistance to exporting and the methods of control already referred to flourish.

The consequences are particularly severe in that the immunity is not confined to the foreign private sector. Foreign investments no longer constitute the unintegrated enclaves they generally once did. Echoing the change in accent from extractive export-oriented production to import-replacement the tendency everywhere is to set up joint ventures with local partners. Such partners can provide funds; they are invaluable as intermediaries with local labour, local suppliers, local sales outlets; they know their way through every crack and crevice in the wall of bureaucracy; above all, they provide a fulcrum for the positive levering of government policy.

For their part, the local partners see in foreign collaboration an escape from penury in knowhow and foreign exchange, a ready weapon in the internal competitive struggle and—in particular—a source of indirect extraterritorial advantage; their foreign partners’ low threshold of tolerance is an invaluable alibi, to be used in beating back taxation forays, or in annexing state projects for the private sector; while their direct links with foreign capital defuses many official threats to introduce outside competition to break local monopoly. Indeed so long as foreign investors are prepared to treat with local capital and not exclude it, a common private sector position in dealing with the host government is virtually assured, and with it a positive impact on government policy.

It would be wrong to leave it at that. Governments, even small ones are not entirely without volition or resources. There are passages in the relations between domestic and foreign business in which conflict replaces collaboration and the state is called upon to exercise an arbitrating or defensive function. There are conflicts between the foreign investors themselves and within the domestic private sector. There is the overriding competition between West and East. All of these add to the host government’s arbitrating functions and even provide it with a measure of material autonomy. The result is that underdeveloped countries—even the most backward—are not as defenceless in dealing with the foreign investor as they have been. They clearly do control, regulate and restrain. But unless they are willing to go the whole hog towards full state capitalism with all that that entails in disrupting present arrangements and in possible open conflict, they do these within the narrow limits set by foreign capital’s low tolerance of interference and its ability—together with its domestic partners—to influence positively government’s own aims and methods.

The larger consequences are daunting. They go well beyond a balance-of-payments arithmetic or the perpetuation of technological dependence, or the associated problem of excess imports and excess payment obligations. The real victims of the foreign sector’s substantive extraterritoriality and the lesser immunity it casts on the private sector as a whole are planning, the initiatory role of the state, and with them perhaps, the hope for economic development.

In this light, to propose as Pearson does, “a larger flow of foreign investment” is to condone the continued desperation of the underdeveloped world. That the proposal stems from bad premises rather than bad faith hardly matters.

Notes