ASEAN-U.S. Economic Relations: Private Enterprise as a Means for Economic Development and Co-operation 9789814376945

Table of contents :
Contents
List of Tables
List of Figures
Foreword
Contributors
1. Introduction to the Role of the Private Sector in ASEAN-U.S. Economic Relations: An ASEAN Perspective
2. Private Enterprise in Development
3. New Needs and Policy Framework for Private Investment in ASEAN (and the United States)
4. Privatizing Public Utilities
5. Experiences in Privatization
6. Promotion of Private Investment: Technical Assistance
7. Promotion of Private Investment: Institutional and Legal Infrastructures
8. Venture Capital and Investment Promotion in ASEAN
9. Franchising in the ASEAN Nations
THE EDITORS

Citation preview

ASEAN-U.S. ECONOMIC RELATIONS

The ASEAN Economic Research Unit (AERU) is an integral part of the Institute, corning under the overall supervision ofthe Director who is also the Chairman of its Management Committee. The Unit V'as formed in 1979 in response to the need to deepen understanding of economic change and political developments in ASEAN, The day-to-day operations of the Unit are the responsibility of the Co-ordinator, A Regional Advisory Committee, consisting of a senior economist from each of the ASEAN countries, guides the work of the Unit. The Institute of Southeast Asian Studies (!SEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer,

ASEAN- U.S. ECONO MIC RELATI ONS Private Enterprise as a Means for Econom ic Develop ment and Co-oper ation

Edited by

Joseph LH. Tan Narongchai Akrasanee

I5EA5 ASEAN Economic Research Unit : nstitute of Southeast Asian Studies

Published by Institute of Southeast Asian Studies Heng .'vlui Keng Terrace Pasir Panjang Road Singapore 0511 All rights reserved. 1\o part of this publication may be reproduced, stored in a retrieval sy,tem, or transmitted in any form or by any means, electronic, mechanical. photocopving, recording or otherwise. without the prior permission of the Institute of Southeast Asian Studies.

© 1990 Institute of Southeast Asian Studies The re.lj)()nsibilityforfacts and opinions in this publication rests exclusively with the authors and their intnjn"Ptations do not necessarily riflnt the views or the policy oft he Institute or its sujJj)()rters. Cataloguing in Publication Data ASEA.\1-L'.S. economic relations: private enterprise as a means for economic development and co-operation I edited by Joseph Tan LH. and :-.larongchai Akrasanee. Papers presented at a svmposium held on 6-8Julv 1989 in Singapore. l. ASEAl\ countries-Foreign economic relations-Cnited States-Congresses. 2. United States-Foreign economic relations-ASEA.l\1 countries-Congresses. 3. Business enterprises-ASEA.'\/ countries-Congresses. 4. Business enterprises-United States-Congresses. 5. Privatization-ASEAl\ countries-Congresses. 6. Imestments-ASEAN countries-Congresses. 7. ASEA.\1' countries-Economic policv-Congresses. I. Tan, Joseph Loong Hoe. II. Narongchai Akrasanee, 1945III. Title: Private enterprise as a means for economic development and cooperation. HF1592.5 U6A844 1990 sls90-135220 ISB0! 981-3035-71-4 Typeset by International Typesetters Printed in Singapore bv Loi Printing Pte. Ltd.

Contents

List ofTables List ofFigun:s Fornvord Contributors

1X

Xl

1. Introduction to the Role of the Private Sector

in ASK~~-U.S. Economic Relations: An ASEAN Perspective Joseph L.H. Tan 2. Private Enterprise in Development Grmld l\1. Airier 3. New Needs and Policy Framework for Private Investment in ASEAL'\J (and the United States) Florian A. Alburo

17 41

4. Privatizing Public Utilities Lim Chin and Linda Low

52

5. Experiences in Privatization Paul Chan and ioh Kin Woon

77

6. Promotion of Private Im·estment: Technical A~sistance Stephen Guisinger

92

7. Promotion ofPrivate Investment: Institutional and Legal Infi·astructures Djisman S. Simandjuntak

110

8. Venture Capital and Investment Promotion in AS~l\J M. Louise Curle)'

126

9. Franchising in the ASEAN Nations Robett Tfustis and Ben Kedia

140

Ust of Tables

l.l

1.2 1.3 1.4 1.5

1990-91 Forecast of Real Economic Growth in ASFAN and the Asia-Pacific 1990-91 Forecast of Real Export and Import Growth in A5E&'\T and the Asia-Pacific Manufactures as a Percentage of Total Imports ofJapan and the lT nited States, 1983-88 Investment Approvals in Southeast Asia, 1988 Number ofTouristArrivals in ASEAN and the PECC Economies

3 4 ::>

7 9

3.3

Japan and the United States: DFI Flows to ASEAN, 1986-88 Direct Foreign Investment as a Percentage of the Gross Domestic Capital Formation of ASEAN, 1986-87 Export Direction, ASEA..'\1-China-PECC-EC, 1970 and 1988

43 44

4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9

Electricity Production and Sales, 1963-87 Gas Production and Sales, 1963-87 Water Consumption, 1963-87 Electricity Tariff~ 1978-87 Gas Tariff; 1978-87 Water Tariff, 1978-87 Capital Expenditure, 1978-87 Revenue and Rate of Return on Fixed Assets of the PUB, 1978-87 Sales Revenue and Cost per Unit Sold, 1978-87

59 60 61 63 64 65 66 67 68

3.1 3.2

6.1 Characteristics of Factor-Based and Trade-Based Incentives A6.1 Incentives and Disincentives

42

95 108

7.1 7.2 7.3

Gross Capital Formation as a Fraction of GDP Infow of Foreign Direct Investment to ASEAN Repayments of Foreign Long-Term Loans

Ill 112 113

8.1 8.2 8.3 8.4

U.S. Venture Capital Firms, 1988 Distribution of GDP /GNP, 1985 Exports as a Percentage of GDP /GNP U.S. Trade with ASEAN, 1988

128 129 129 130

hllojTablt.\

8.5 8.6 8.7 8.8 8.9 8.10 8.11

U.S. Direct lnyestment in ASEAN, 1988 SEAv1Investments in Singapore Transtech Singapore Investment Portfolio, May 1989 ASEAN Stock Market Data, End 1988 Ratio of Stock Market Capitalization to GDP, 1987 Changes in Stock Prices, End 1985 to End 1988 Exchange Rate Changes against the U.S. Dollar

9.1 9.2

International Franchising: Location of Establishments, 1986 International Restaurant Franchising: Location and Number of Establishments, 1986 Franchising in ASEAN

9.~)

·uii

130 132

133 133 134

134 13:)

144 145 147

Ust of Figures

Rate of Return on U.S. Investments in Asia, 1988 1.1 l.2(a) Changes in japan's Investment in the Manufacturing Industry in ASEAN and China l.2(b) Changes in japan's Investment in the Manufacturing Industry in the Asian NIEs Growth in Visitor Arrivals 1.3 9.1 9.2 9.3 9.4 9.5 9.6 9.7

International Franchising, 1986 Franchising Starting Strategies in ASEAN Master Franchisee Organization Joint-Venture Organization Licensing Organization Direct Investment Organization Government-Controlled Franchise Organization

2 6 6 10 142 149 149 150 151 152 153

Foreword

The ASEAN Economic Research Unit (AERU) of the Institute of Southeast Asian Studies (ISEAS) was formed in 1979 to promote research, critical thinking, and debate on the economics and related political issues of the Association of Southeast Asian Nations (ASEAN). Priority areas identified for research and discussion include investment, industry, and trade; finance and monetary aspects; food, energy, and commodities; transportation/shipping; and political factors in ASEAN economic co-operation. Within these, work relating to ASEAt"J economic relations with its main trading partners and sources of investment has been most prominent, including the project on "ASEAt"J-U.S. Economic Relations". This project has been designed as a three-year undertaking, each year focusing on a distinct but related aspect of the economic links between ASEAN and the United States. The theme for the first year was "The Current State of ASEAN-U.S. Economic Relations". For this, eight papers were commissioned and presented at a workshop on 22-24 April 1985 in Singapore. They covered patterns of trade between ASEAN and the United States; U.S. investment in ASEAN; transfer of technology by U.S. transnational corporations and contractual arrangements; ASEAN manufactured exports to the United States; U.S. exports of goods and services to ASEAN; and the impact of U.S. policy mix on the ASEAN economies. Summaries of these papers were published as a monograph, ASEAl\!-US. Economic Relations: An Oven1iew, edited by Agustin Kintanar, Jr. and Tan Loong-Hoe. The revised papers themselves were subsequently published in full in the November 1986, March 1987, and November 1987 issues of the ASJ.:AN Economic Bul!Rtin, one of the Institute's journal. The research during the second year of the project focused on "Changes in ASEAN-U .S. Economic Environment: Constraints and Opportunities". Eight papers again were prepared which examined the following topics: economic trends in the United States and their implications for ASEAN; increasing protectionism and its implications for ASEAN-U.S. trade and investment in services; U.S.-Thai relations: selected case-studies in agribusiness; and the role of U.S. official development assistance in ASEAN. These papers were discussed at a workshop in San Francisco jointly organized by the Institute and the Asia Foundation's Center for Asian Pacific Affairs (C::APA). The Asia Foundation established the Center in its San Francisco

X

Foreword

headquarters in 198.5 with the goal of promoting communication and strengthening relations between the United States and nations of Asia and the Pacific. The papers were revised and published as ASEAN-U.S. Economic Relations: Changes in the Economic Environment and Opportunities in 1988. The third year of the project carries the theme "Private Enterprise as a Means ofDevelopment and Co-operation". Nine papers were prepared and presented at a symposium held on 6-8 July 1989 in Singapore. These papers cover a range of topics including private enterprise in development; new needs and policy framework for private investment in ASEAN (and the United States); private imestment in public utilities; experience in privatization; promotion of private investment- technical assistance; promotion of private investment- institutional and legal infrastructures; venture capital and investment promotion; international franchising; and backward and forward linkages of direct foreign investment. The Institute of CAPA received assistance from several institutions during the workshop and the preparation of this volume. Both the Institute and CAPA would like to acknowledge their appreciation of such help. They are grateful to the A~ia Foundation for its financial support for the project as a whole, as well as to the researchers and editors for their contributions and co-operation in expediting the publication process. Responsibility for the accuracy of statements rests exclusively with the editors and the individual authors. Allen C. Choate Executive Vice-President Center tor Asian Pacific Mfairs The Asia Foundation San Francisco

Kemial S. Sandhu Director Institute of Southeast Asian Studies Singapore

Contributors

Florian A. Alburo is Professor of Economics at the University of the Philippines. He is the Chairman of the Editorial Board of the journal ofPhilippine Develojnnent, Philippine Institute for Development Studies. He was formerly Under-Secretary of Socio-Economic Planning (Deputy-Director General) of the National Economic and Development Authority, Government of the Philippines. Paul Chan is presently the Chief Executive of the Asia-Pacific Capital Corporation (APCC), a private firm with investments in manufacturing, trading, management, and consultancy. He was formerly an Associate Professor and Chairman of the Division of Applied Economics in the Faculty of Economics and Administration, University of Malaya. He has acted as an economic consultant to the Government of Malaysia, various local bodies and many international organizations. M. Louise Curley is currently engaged as a consultant on international economics to the International Group of Scudder. She was formerly an economist at Scudder Stevens and Clark, Investment Counselors, New York. Djisman S. Simandjuntak is currently the Executive Director of the Institute of Management Prasetya Mulia,Jakarta. He was formerly Head of the Department of Economic Affairs, Center for Strategic and International Affairs, Jakarta. Stephen Guisinger is Professor of International Management Studies at the University of Texas at Dallas, where he also serves as Co-Director oftheJoint Center for China-U.S. Management Studies. He is also a consultant to the Foreign Investment Advisory Service of the World Bank and the Center for Su-ategic and International Studies in vVashington, DC and a member of the U.S. National Committee on Pacific Economic Co-operation, where he heads a task force on foreign direct investment in Southeast Asia. He was the principal author of Investment Incentives and Pe~formance Requirements (1985) and has also recently completed (with Gerald W. Scully) a monograph for the World Bank entitled The Timing and Sequencing of Trade Liberalization Policy ( 1990).

XII

Con tributor:'

Robert T. Justis is a Professor of Management in the College of Business Administration at Louisiana State University, where he founded the Society of Franchising and developed its International Franchise Center. He has published numerous refereed articles and books including the best-selling Franchising (with RichardJudd, 1989). Ben L. Kedia is Professor and Robert Wang Chair of Excellence in International Business at Memphis State University, Memphis, and has been the Director of the Robert Wang Center for International Business since 1989. He has published widely in the field of international business policy and franchising. Lim Chin is currently an Associate Professor in the Faculty of Business Administration at the National University of Singapore. He was formerly a tenured Associate Professor of Economics at the University of Western Ontario, Canada. Dr Lim has published widely in the leading journals of the profession such as the American Economic Review, Journal ofEconomic Themy, Economica, European Economic Review, Canadian Journal of Economics, and Transpmtation Research. His published

works are in the areas of microeconomics, industrial organization theory, and applied economics.

Linda Low is a Senior Lecturer in the Department of Economics and Statistics, National University of Singapore. She was a Research Fellow at the Economic Research Centre, University of Singapore between 1975 and 1978. Her recent publications include Entrepreneurship in Singapore (with Lee Yuan, 1989) and An EconomicFramewark ofthe Singapore Economy: Princip!Rs and Issues (with Toh Mun Heng, 1990). Gerald M. Meier is Konosuke Matsushita Professor of International Economics and Policy Analysis at Stanford University. Prior to joining Stanford in 1963 he had been Chester D. Hubbard Professor of Economics at Wesleyan University and had taught at Williams College, Yale University, and the University of Oxford. He is the author of a number of books on international economics and economic development. His latest works include International Economics: Themy ofPolicy (1980), Problems of a World Monetary Order (2nd edition, 1982), Pricing Policy for Development Management (1983), Emagingfrom Poverty (1984), Pioneers in Development (1984), Pioneas in Development, Second Series ( 1986) , Financing ofAsian Development ( 1986) , and Leading Issues in Economic Development (5th edition, 1989). Some of his forthcoming titles are The New PolitiralEronomy andDevPlopment Policy making and Managing in an Economy without Borders.

Joseph L.H. Tan is a Senior Fellow at the Institute of Southeast Asian Studies. He is also Co-ordinator of the Institute's ASEAN Economic Research Unit, and has been editor-in-charge of the ASEAN Economic Bulletin since mid-1985. His recent publications include Trade, Protectionism, and Industrial Adjustment in Consumer Electronics Industry: Asian Responses to North America (contributor and co-editor with

Contrilmtors

xiii

Chia Siow Yue, 1989), Trade, Protectionism, and Industrial Adjustment in Vegetable Oils: Asian Responses to North America (co-editor with Shankar Sharma, 1989), and My an mar Dilemmas and options: The Challenge ofEconomic Transition in the 1990s (coeditor and contributor with Mya Than, 1990).

Toh Kin Woon is an A~sociate Professor in the Faculty of Economics, Universiti Kebangsaan Malaysia. He has researched and written on the role of the state in development, causes of poverty and its eradication, and the impact of Japan's industrial restructuring on investments in ASEAN. He has also acted as consultant to the state government of Sarawak, local bodies, and some international institutions. He is currently involved in a research project of the V\1orld Institute of Development Economics Research (WIDER), Cnited Nations University, on 'Trade and Industrialization Reconsidered".

1

Introduction to the Role of the Private Sector in ASEAN-U.S. Economic Relations: An ASEAN Perspective Joseph L.H. Tan

Private-Sector Opportunities in ASEAN Rapid or dramatic regional economic changes throw up emerging business opportunities as well as uncertainties and risks which private entrepreneurs and investors both inside and outside the region evaluate cautiously as they contemplate whether to expand their business commitment or not. Economies in the Southeast Asian region offer mixed but tantalizing opportunities for investors and multinationals from countries outside the region, particularly from the United States. The economies of the Association of Southeast Asian Nations (ASEAN) with their continuing excellent track record of economic growth and political stability undoubtedly have their attractiveness, offering significant to substantial yields to capital and entrepreneurship. For instance, Singapore was rated the most profitable location in Asia (and the third most profitable world-wide) in 1988 for LT .S. manufacturing investments. Malaysia and Thailand too received very favourable ratings, especially the former, where the rate of return of U.S. affiliates increased dramatically from 6.8 per cent in 1987 to 35.4 per cent in 1988. Both Singapore and Malaysia performed even much better than the other three A~ian tigers- South Korea, Hong Kong, and Taiwan (see Figure 1.1).

Economic Performance and Emerging Trends in ASEAN A recent report indicates that the most successful economies yielding the best growth performance in the Asia-Pacific are presentl)"vithin ASEAN (Pacific Economic Outlook 1990-1991). Above-average growth rates are expected for all the ASEAI\' countries (excluding Brunei Darussalam), with Thailand leading Singapore and Malaysia in growth statistics (see Table 1.1). But what are the factors accounting for this favourable and continuing economic growth and development? Four trends or underlying causal factors can be identified (Asian Development Bank 1990, pp. 1-50; Pacific Economic Outlook 199(~1991, p. 5;

2

Joseph LH. Trzn

FIGURE l.l Rate of Return on U.S. Investments in

A~ia,

1988

50

40.5 40-

TT ..

w~.I

I

30

(/)

35.4

29.8 27.1

Q)

Ol C\J

c

Q)

()

(ij

I

0..

E

20

n

I' 'H •·~,----'r .

1

226 . r

I

_

I

19.9

1

,

10

Ol

Q)

00.. C\J Ol

c 0

~

Ol

c

c

i:f.i

I

c

C\J 0..

C\J -,

0

SocRcE: Subramaniam (1990, p. 3).

Capel1989, p. 38): 1. 2. 3. 4.

robust international trade; increasing foreign direct investment (FDI); a surge in tourism and consumption expansion; and a new initiative in sub-regional economic co-operation: the ASEAN "triangle of growth", which is still in its formative stage.

First, the forecast for the ASEA."N economies in 1991 is rapid growth in exports (as much as 20 per cent for Thailand and 11 per cent for Singapore) as well as imports (17.8 per cent for Thailand and 12 per cent for Singapore) .1 See Table 1.2. Indeed, for the ASEAN economies international trade is the engine of growth

Introduction to the Role

ol the Private Sertor

3

TABLE l.l 1990-91 Forecast of Real Economic Growth in ASEAN and the Asia-Pacific (ln percentages) -------------

Real GDP/GNP

1989

1990

1991

2.0 5.9 8.5 9.2 11.0 3.0

2.9 6.4 8.1 5.5 8.1 9.1 2.5

n.a. 5.6 7.5 6.1 6.6 8.4 2.8

NIEs Chinese Taipei Hong Kong Korea

7.2 2.5 6.7

6.9 3.0 7.0

7.3 5.5 7.0

Others Australia Canada China Japan :\few Zealand

4.9 2.9 3.9 5.1 1.4

0.8 1.9 5.4 4.3 2.9

:3.2 1.4 S.9 3.1 1.8

Average of all economies

5.3

S.O

5.2

Region ASEAN-U.S. Brunei Darussalam Indonesia Malaysia Philippines Singapore Thailand United States

-------

- h :J.:J

-------

Sol'lZ< r: Parifir }jonomir Outlook 1990-1991 (table 1, p. 48).

generating expansion in net exports, but more fundamentally to stimulate economic efficiency. Exports enable producing countries to reap international economies of scale through opportunities for international specialization and division of labour, which in turn leads to lower unit cost of production. Imports promote efficiency by freeing resources from inefficient uses to better alternatives including exporting. Hence growth is more than export-led. The traditional pattern of trade in the Asian-Pacific region has been characterized by the exchange of manufactured and primary products between ASEA."J, the newly industializing economies (NIEs), and their major trading partners- the United States principally, in addition to Japan and the European Community (EC). As industrialization in these Asian economies gathered momentum over the years, trade, particularly that in manufartured (components, semi-finished, and final) produrts among these countries themselves, which are at different stages of economic development, grew increasingly important. 2 For instance, for the 1983-88 period, manufactured exports of the ASEAN-4 to the United States increased sharply from 38.3 to 66.1 per cent (see Table 1.3).

4

Joseph L.H. Tan

TABLE 1.2 1990-91 Forecast of Real Export and Import Growth in ASEAN and the Asia-Pacific (In percentages) Export Growth

Import Growth

1989

1990

1991

1989

1990

1991

ASEAN-U.S. Brunei Darussalam Indonesia Malaysia Philippines Singapore Thailand United States

n.a. 15.0 18.0 11.7 11.2 28.7 11.1

n.a. 9.;) 9.9 8.1 18.0 20.9 8.fi

5.0 9.4 8.5 9.1 20.0 9.0

n.a. 11.6 30.1 22.5 11.5 29.0 6.1

n.a. 13.4 14.4 9.0 19.5 22.0 6.1

6.8 7.7 8.9 9.0 12.0 17.8 6.5

NIEs Chinese Taipei Hong Kong Korea

4.9 10.2 -5.2

3.3 5.7 2.2

3.9 8.4 6.0

9.1 8.9 14.2

8.5 6.4 11.0

7.9 8.6 9.0

Others Australia Canada China Japan New Zealand

3.7 -0.9 5.1 12.2 0.3

7.2 0.6 8.6 4.9 3.5

5.5 2.3 9.6 4.9 3.6

20.6 7.2 5.6 19.0 17.4

3.1 3.3 2.5 9.3 3.6

4.5 0.8 3.0 6.3 2.9

9.0

7.9

7.7

15.2

9.4

7.4

Average of all economies

ll.O

Sot'RCF: Pru ific Economic Outlook 1990-1991 (table 2, p. 49).

Second, the robust and fast expansion in intra-Asian trade in recent years has been accompanied by a surge in intra-Asian FDI. See Figures l.2(a) and l.2(b) and Table 1.4. The strong flows ofJapanese and NIE investments into ASEAN are likely to change the regional structure of production and enhance economic growth in the 1990s. Multinational corporations (MNCs) in Asia traditionally prefer to invest in industrialized countries, mainly in real estate, financial assets, and distribution networks to expand or diversify market shares. These flows continue to be considerable but investments are increasingly flowing within the region, distributed in accordance with the changing comparative advantages offered by the developing Asian economies. These "recent waves" of investments have three characteristics: • they tend to focus on projects in the manufacturing sector; • the host countries tend to be resource-rich and labour-surplus ASEAt"J economies; and • they involve an increasing number of small- and medium-sized firms rather than the larger MNCs.

'd"'

TABLE 1.3 ManuEtctures" as a Percentage of Total Imports of Japan and the United States, 1983-RR

"'""c:;· ;:).

;::

---

--------

----

(3"

1983 Million US$

Origin

Million US$

%

- -

126,520

World

-

Japan United States

;,;,

1987

1988

- -

27.2 -

-

1983

1987

c

~

191l8

~

-

%

- -

149,515

.,;;.

United States

Japan

Million US$

-

%

Million US$

49.0

269,878

63.2

43,559

;;. "'

%

Million US$

%

e

424,442

76.6

460,209

78.6

:;:~

98.0

88,074

98.2

93,168

98.1

-

---

44.1

%

Million US$

187,354 -

24,647

50.2

31,490

56.1

42,037

56.0

NIEs Hong Kong Korea SingajJore Taiwan

8,125 670 3,365 1,468 2,622

55.9 81.9 65.3 20.7 55.7

18,812 1,561 8,075 2,048 7,128

66.2 87.1 74.2 42.1 59.6

25,002 2,109 11,811 2,339 8,743

72.9 86.6 79.1 50.7 67.3

29,561 6,825 7,657 2,969 12,110

95.8 96.5 97.1 87.4 96.5

61,283 10,490 17,991 6,395 26,406

96.4 96.9 97.2 91.9 96.7

66,501 10,810 21,209 8,226 26,256

96.7 96.6 97.7 93.6 96.9

ASK'J.N" Indonesia Malaysia Philippines Thailand

15,888 10,432 3,131 1,306 1,019

7.4 3.0 14.4 13.7 21.5

16,348 8,427 4,772 1,353 1,796

13.6 11.6 9.0 20.6 29.5

19,002 9,497 4,710 2,044 2,751

17.9 14.3 12.8 26.8 32.6

11,057 5,657 2,205 2,159 1,035

38.3 7.9 76.1 66.9 64.0

ll,640 3,719 3,053 2,481 2,387

60.8 28.2 81.4 76.2 69.3

13,676 3,494 3,853 2,906 3,423

66.1 32.8 82.4 76.8 72.6

---

--

---

---

----

---

----

- -

;o c

"~

- -

-Not applicable. "Defined as SITC (5 + 6 + 7 + 8). 1 ' Not including Singapore and Brunei. No data were available for Brunei. SmrRr Hawaii, and only indicate arrivals by air. Sm,Ru:: Mitsui Research Institute ( 1988); Parifirlc'mnornic Outlook 1990--1991 (table I, p. 48); Pacific Association of Travel Agencies (1980-88); World Tourist Organization (1!-!80-88).

10

Joseph L.H. Tan

FIGURE 1.3 Growth in Visitor Arrivals (In percentages)

40,--------------------------------------------------------.

rn

Ql

g>

~ 20 ~

Ql

c.

E

Hong Kong Malaysia Philippines Singapore S. Korea : 1986

~ 1987

EZJ1988

Taiwan

Thailand

2.2J1989*

* F-- Forecast figures. SoncE:James Capel (1989, p. 32).

over the last three years. The combined effect of both domestic and external private consumption expenditure has emerged to be a major engine of growth in both ASEAN and the NIEs, accounting for 50 per cent of net GDP /GNP in 1988 and beyond (Capell989, p. 33). The ASEAN "Triangle of Growth"

A new concept of sub-regional economic co-operation within ASEAN amongst Indonesia, Malaysia, and Singapore is presently in its formative stage of implementation. 3 This concept was first proposed by Mr Goh Chok Tong, Singapore's First Deputy Prime Minister, in December 1989. Co-operative efforts would generate complementary interdependence - Batam and Johor could provide resources such as land, gas, water, and labour for industries while Singapore could provide management expertise, and financial and infrastructural services. Malaysia and Indonesia have also identified tourism as one of the joint activities which could be promoted as Malaysia is currently having its "Visit Malaysia Year", and Indonesia will be promoting the "Visit Indonesia Year" in 1991. Both these

Introduction to the Role of the Private Sector

11

countries could benefit from the spill-over of tourists from Singapore. Furthermore, the prosperity and spending power of Singapore would have a "spill-over effect" on the tourism industry of these ASEAN neighbours. Indeed, whatever dissimilarities may arise from level of development, physical size, and population in these three ASEAN economies, there are opportunities for capitalizing on one another's comparative advantages. Besides, the integration of economic development would further enhance economic co-operation, strengthen relations, and give each country a stake in the progress and prosperity of its neighbours. Such sub-regional, int:ra-ASEAN co-operation augurs well for sustained and shared economic growth in the 1990s. These emerging trends in ASEAN- robust international trade, increasing FDI, a surge in tourism and consumption expansion, and the new initiative in subregional economic co-operation (an ASEAN "growth triangle") to promote the development of the private sector- open up possibilities for ASEAN-U.S. private initiatives and ventures. Scope for ASEAN-U.S. Private-Sector Initiatives and Ventures As in the Manila Summit declaration in December 1987, it is notable that the Twenty-Third ASEAN Ministerial Meeting in July 1990 underscored the role of the private sector: The Foreign Ministers acknowledged the growing importance of private sector participation in the dialogue process as well as in intra-ASEAN co-operation and expressed the hope that such participation would be intensified. Qoint Communique, 24-25July 1990)

Yet again another senior ASEAN minister, Malaysian Finance Minister Daim Zainuddin, affirmed in early 1990 the continuing emphasis on private-sector activities to stimulate regional economic growth, national development, and increasing efficiency all around: The gradual withdrawal of the public sector from participating directly in economic acti\~ties has led to a mare pronounced role for the private sector. This is a development which I feel augurs well for ASEAN co-operation. The private sector has always displayed an inherent flexibility to adapt and respond quickly to changing situations; it does not suffer from the bureaucratic red tape that afflicts public administration. (Daim 1990, p. 7, emphasis added)

And one may add that non-ASEAN private-sector players, especially those from the United States, can contribute to the positive-sum game, thus generating further shared growth and development for all. To stimulate faster economic development, the ASEAN economies have been relying more on the private sectaras the engine of economic growth (Ng and Wagner 1989; Nomura Research Institute 1989). The role of the government either as goal-setter and planner, regulator, or direct producer/entrepreneur has become less important. The reasons for these developments vary from one country to another. In Malaysia and Indonesia, for instance, the greater dependence on the

12

Josrplz L.H. Tan

private sector was forced by serious difficulties in implementating tl1e development of their economies. As has been widely recognized, the most successful economies thrive on competitive markets and private enterprise (Naya 1988; Hanke 1987). The clarion call to let the private sector lead national and regional economic progress has become generally accepted. However, the public sector continues to have a crucial role to play; and World Bank President A.vV. Clausen's formulation of an appropriate framework for the efficient and effective operation of private enterprise responsive to the promotion of economic welfare and high returns to entrepreneurs is comprehensive and useful. His "coherent economic ground rules" for the government to promote the development of the private sector comprise the following ten specifications (Clausen 1985): 1. the adequate provision of physical infrastructure such as roads, ports, power, and so forth; 2. the minimizing of market distortions and rigidities so that the prices of capital, labour, for-eign exchange, and products reflect their relative scarcity; 3. assured access to inputs and markets; 4. support for research and the dissemination of its fruits; 5. relatively unrestricted entry into any industry; 6. the extension of considerable autonomy to entrepreneurs in their investment and managerial decisions; 7. respect for contractual obligations; 8. the protection by law of property rights, including intellectual property; 9. the consistent and uniform application of government policies to ensure fair and equal treatment among sector-s and firms, including nondiscrimination between foreign and nationally owned enterprises, and the right of foreign investors to remit capital and earnings; and 10. the adherence to agreements ensuring independent arbitration of investment disputes and the provision of insurance cover against political risks. Indeed, the authorities in the ASEAN economies seem to recognize the importance of these diverse characteristics in their co-operative efforts to promote the "triangle of growth" as a pragmatic institutional catalyst to stimulate the development of the private sector. The trend of growing intra-ASEAN trade has enabled Singapore to play the important role of a "regional procurement centre", where products from the other ASEAN countries are processed and then re-exported to developed countriesthe United States, Japan, and the EC. Besides, there are excellent opportunities for American investments to yield relatively high returns in Singapore and the other ASEAN countries (see Figure 1.1). The continuing sustained growth of the United States accompanied by a rapid increase in the import of ASEAN product~ (manufactures and primary commodities) open up possibilities for more joint ventures not only for big companies but medium-sized ones as well. There could be co-operation in the division oflabour, with U.S. entrepreneurs managing the

Introduction to the Role of the Private Sertor

13

demand side of marketing products within the United States while their local counterparts, who are knowledgeable in the local business culture, manage the supply side of production. American technologies lead the world in many industries, especially in a number of areas of basic research and development, including high-tech industries such as telecommunications and information technology, biotechnology, and new materials. Indeed, these are the industries which some ASEAN inYestmentpromotion authorities, such as Singapore's Economic Development Board, are promoting as their "niche" or priority industries (Economic Development Board 1989, pp. 40 ff.; New Straits Times, 26July 1990, p. 21; Paitoon 1990). American and A5EAN firms can develop viable joint ventures to explore trade and investment opportunities in resource-rich and labour-rich or labour-surplus economies in the ASEAN region. For instance, Singaporean or other ASEA_N firms, as for American ones, are increasingly experiencing some pressure or attraction to invest overseas. Some Singaporean or other ASEAN bankers rald i'vf. iHtier

forms: ( 1) the market does not function properly - the case of market imperfections; ( 2) the market result is incorrect- the case of externalities; ( 3) no market exist~ for the relevant activity- the case of public goods; and (4) the market yields undesirable results in terms of objectives other than resource allocation for example, income distribution. vVhat the early development economists did not emphasize, however, was that although market failure may provide a rationale for public policy intervention, this is only a necessary, not a sufficient, condition for government intervention. The realized inadequacies of market outcomes must be compared with the potential inadequacies of non-market efforts to ameliorate them: market failure must be weighed against government failure. Indeed, the actual practice of planning soon became disappointing. A number of biases dominated the actual planning processes: a bias towards macro models and macro plans to the relative neglect of microeconomic considerations; a bias towards the quantifiable to the relative neglect of elements that are not quantifiable but are of crucial importance (for instance, many aspects of human resource development and socio-cultural and political changes for which inadequate or no data exist); and a bias towards the formulation of a development plan without sufficient regard for its implementation. As for their substantive content, many development plans emphasized inwardlooking policies to the relative neglect of outward-looking policies, the development of the urban industrial sector with much less concentration on rural development, and the simple imitation of the advanced countries at the expense of innovation and adaptation. 1 An underdeveloped economy soon gave rise to an over-extended state, with a very high cost of government. One critic of the practice of development planning listed the following causes of poorly planned performance: l. deficiencies in the plans: they tend to be over-ambitious, to be based upon inappropriately specified macro models, to be insufficiently specific about policies and projects, to overlook important non-economic considerations, and to fail to incorporate adequate administrative provision for their own implementation; 2. inadequate resources: incomplete and unreliable data; too few economists and other planning personnel; 3. institutional weaknesses: failures to locate the planning agency appropriately in the machinery of government; failures of communication between planners, administrators, and their political masters; the importation of institutional arrangements unsuited to the local circumstances; 4. failings on the part of the administrative civil service: cumbersome bureaucratic procedures; excessive caution and resistance to innovation; personal and departmental rivalries; lack of concern with economic considerations. (Killick 1976, p. 164) In practice a comprehensive type of planning accentuated inflationary pressures,

Privatr Entetprisr in Drvelopmrnt

19

reacted on the supply of private entrepreneurship, hindered the full realization of investment potentials in the private sector, led to inefficient industrialization with projects that were handicapped by technical difficulties and excess capacity, and neglected the strategic importance of agricultural growth and export promotion. Towards the end of the 1950s, Professor Harry G. johnson (1958), with the Asian nations in mind, felt compelled to make a 'trong ca'e tor the market mechanism as against detailed planning ... because the market figures re latin·ly little in the literature of economic development, and the theoretical analysis which economics has developed in relation to markets is often overlooked or disregarded.

Moreover, during the 1960s and 1970s, there was increasing concern over policyinduced distortions and the non-market failures associated with the implementation of public policies. The resurgence of neo-classical economics after 1960 caused a rethinking of the respective roles of the public and private sectors." The neo-classical resurgence emphasized the private market-price system and the role of private enterprise. Instead of relying on comprehensive and detailed administrative controls, the government should provide price and income stimuli to expand private output, increase exports, and enlarge domestic markets. Price changes should extend to foreign exchange rates, interest rates, tariffs, taxes, and subsidies. Of most importance was the need to remove distortions in internal price relations that had resulted from the use of numerous specific controls. Accordingly, many economists advocated the adoption of flexible exchange rates to avoid currency overvaluation, the removal of price controls on foodstuffs, and the liberalization of foreign trade controls. The objective was to provide pre~sures and incentives for improved economic performance by private enterprise and to remove price distortions created by government intervention. Most heavily criticized \Vas the strategy of import-substituting industrialization. This strategy was blamed for a number of government-induced price distortions. Interest rates were too low in the urban sector, wages for unskilled labour too high, agricultural prices too low, and foreign exchange was undervalued. Recogn1zing that these price distortions caused inefficiency in resource allocation and inhibited the mobilization of resources, many came to accept Professor Peter Timmer's often-quoted observation that "getting prices right is not the end of economic development. But getting prices wrong frequently is" ( 1973, p. 76). Criticisms came to be directed at a widening range of governmental activities - at a disequilibrium system and a set of trade, fiscal, financial, industrial, and wage policies that were seen to be contradictory and self-defeating. The plea to "get prices right" became more generally to "get policies right". Neo-classical economics, with its emphasis on the private market-price system and its enhanced role for private enterprise, was to be the safeguard against policy-induced distortions and government failure. It was now recognized that it was not differences in the initial conditions but rather differences in the policies that were taken in different developing countries that explained the disparate performances of developing countries. A country was

20

G!'rald }vf. 1vfein

poor not because ofthe vicious circle of poverty, but because of poor policies. Not adverse external conditions, but inappropriate domestic policies explained why some countries were not taking advantage of their external economic opportunities. Neo-Classical Political Economy of Government Intervention In recent years, building on from neo-classical economics, a number of economist~ have extended the case against government intervention by applying the analysis of neo-classical political economy. Prior to the development of neo-classical political economy, only too often the policv-maker remained exogenous in economic analysis, and the state was simply assumed to pursue the public interest or Pareto efficiency. The state and the actual process of policy-making remained in black boxes. Now, however, in order to determine why the government undertakes the policies that it does, neo-classical political economy attempts to endogenize the policy-maker and analyse the political process in neo-classical economic terms. The analysis is composed of various strands of thought: public choice, collective choice, transaction costs, property rights, rent-seeking, and directly unproductive activities. In this analysis the government cannot be viewed as a platonic guardian nor as a benevolent dictator achieving Pareto efficiency or maximizing a social welfare function. l\io longer can development economists refer, as in earlier days, to a Pigou-Meade or Bergson-Samuelson type of planner. Denying that governments are the agencies of public interest, the new political economy has gone on to designate a typology of government that focuses on the state as a Leviathan or predatory state, or as factional, or as bureaucratic. The Leviathan model interprets government as seeking profits and rents from the activities in which it engages. Such an objective explains the imposition of quantitati,·e restrictions, tariffs, bulk buying, controls m·er wholesale, and retail trade. Another objective of Leviathan is likely to be net revenue maximization. In this predatory view of the nature of government, the state preys on it~ citizens, with an insatiable appetite for revenue that it consumes for its uwn sake (Findlay and Wilson 1987, p. 290). Findlay and Wilson remind us, however, that the state may also be productive. The provision of public goods (security, law and order, irrigation, and roads) raises the productivity of the economy above the level that would exist without the state (anarchy). Viewing the state as an institution that is intrinsically both productive and potentially predatory in character, Findlay and Wilson attempt to capture this dual character i.n a ~i.mple general equi.li.bri.um model. The ~overei.gn i.~ i.ntere~ted i.n the surplus of revenue over expenditure and therefore equates marginal revenue to marginal cost of hiring more government workers.~' Findlay and V\'ilson view the state as a "natural monopoly", and the "surplus" that the state maximizes is a sort of monopoly "rent" that the sovereign can enjoy. But they then postulate that the surplus originally enjoyed purely by the sovereign attracts a horde of office-seekers anxious to get their hands on some of it. A

Private Fntnprisr in Drvclopmrnt

21

monarchial-type Leviathan may thus be transformed into a bureaucratic Leviathan. A budget-maximizing hypothesis is then attributed to the behaviour of the bureaucratic Leviathan. At the other extreme from a Leviathan acting in an autonomous fashion is the interpretation of the state as a passive reflection of interest groups. Viewed in principal-agent terms, citizens are the principals and politicians the agents who are to conform to the objectives of the principals. The principals are especially in teres ted in transfers- in policy issues of who gets what. Where elections matter, politicians undertake transfers so as to maximize the possibility of re-election. V\'here politicians worry about a take-over, they may try to avoid con testability and deter entrants by courting their support through favourable measures of distribution." The modelling of a factional state has been especially prominent in the explanation of agricultural policies. As Michael Lipton has incisively emphasized, the "urban bias"' of governments results in the transfer of surpluses from agriculture to the urban, industrial sector. Where low prices are paid to farmers, urban consumers benefit. Where state marketing boards implicitly tax the rural sector, the government's revenue from export sales is often used on non-traded services supplied by the urban sector (government employees in bureaucracies, the military, and state industrial enterprises) (Lipton 1977). vVhere governments subsidize inputs for farmers, the benefits of these subsidies are appropriated by a minority of large-scale farmers. V\'here an overvalued exchange rate is maintained, domestic food producers face higher levels of competition from inexpensive foreign foodstuffs. And where import-substitution policies protect local industries, the prices of goods that farmers consume are higher than world prices. Although a political economy approach has been applied most frequently to food price policy, we could also interpret trade policy, stabilization policy, or balance of payments adjustments as the outcome of political pressures extended by various interest groups. We should also analyse the activities of the public bureaucracy in order to illuminate why governments do what they do. The political economy of public bureaucracies merits special emphasis because of the large public sector, extensive public projects, and state-owned enterprises in a developing country. It is necessary to capture both the bureaucratic and political dimensions of administrative performance. The new economics of organization can help do this by allowing us to incorporate a contractual perspective on organizational relationship, a focus on hierarchical control, and formal analysis via principal-agent models. To minimize problems of adverse selection and moral hazard, it is rational for a government to internalize contracting relationships by extending its own bureaucracy instead of engaging in market-like transactions with private contractors. The administration of government regulations acquires particular importance when markets do not clear and there are disequilibrium prices. For then bureaucratic allocation can grant favours, premia, and rents to particular individuals or groups. Through these administratively conferred benefits or through the threat

of sanctions, bureaucratic controls can be used to organize political support and maintain the regime in power. The foregoing interpretations of the role of the state ha\'e the merit of departing from the economist'~ usual notion of a benevolent, well-informed state acting in the public's interesL The actual behaviour of a government is far from the economist's technocratic view of a government maximizing a social welfare function subject to resource and technological constraints. These insights of the new (neo-classical) political economy strengthen the case against planning and against a large role for the public sector. They also indicate why government intervenes with inappropriate policies. The implication is that development efforts must now lie all the more with the functioning of the marketprice system and a stronger private sector.

The Case for Promoting Private Enterprise In view of the experience with non-market (public-sector) failures, it is understandable that more attention should be given to private enterprise in ASEAN. Since 1980 developing countries have also had slower growth because of the slowclown in world economic growth, depressed commodity prices, reduced real resource u·ansters, and debt burdens. This in turn has led to falling real publicsector revenues, limited resources for development spending, and a smaller scope to raise revenues bv increased taxation. At the same time, demands on government expenditures have been intense. It has been necessary to reduce the share of government expenditure in gross national product (GNP) and to avoid the costly burdens of state-owned enterprises that constitute a drain on budget and credit resources. In a positive sense, the case tor promoting private enterprise in a developing economy is intimately related to the benefits that can be realized by relving more on the private market-price system and market-oriented policies. The merit ofthe private market-price system should be emphasized for its contribution to efficient resource allocation and for its provision of incentives for economic growth. The

market mechanism is also an eilecti\·e adnlinistratise instrument that can be used to achieve policy objectives while amiding the inefficiencv, rent-seeking, illegal parallel markets, bureaucratic exploitation, and corruption that result from direct quantitative controls. Vll1en participants in the market are private enterprises, the most important functions of prices are information, allocation, rationing, mobilization, and distribution. All ofthese are important in allowing private enterprise to contribute to a country's development bv responding to the market signals of a price system. The informational hmction of prices is crucial. By providing market signals, a private market-price system is an inexpensive mechanism to guide economic agents in decision-making. Because a price is a substitution ratio indicating the rate at which one thing can be exchanged for another, it facilitates a decision. The decisionmaker need not incur the cost of searching for alternatives. In the absence of the market, a decision-maker faces greater uncertain tv. Private market-prices, however,

Privatr },'nterjJiisr in LJnwlopment

represent informational efficiency and allow the operation of a decentralized economy in which economic decisions are made by individual producers and consumers. The multitude of individual production and consumption decisions is harmonized by the market-price system. To allocate scarce resources among competing ends is the prime function of a price system. In response to a rise in demand in one sector of the economy, price will rise, profits may temporarily increase, and resources will accordingly be attracted to the expanding sector away from another sector in which demand is stable or declining. The price rise provides an inducement for reallocation of resources to the expanding sector. Similarly, a decline in demand would act as a disincentive, and resources would be withdrawn from the declining sector. The commoditv composition of production is thus determined by the market mechanism in conformity with changes in the pattern of demand. And the allocation of labour, land, and capital inputs will respond to the changes in demand for final outputs. The more perfectly markets are organized - in the sense of being more competitive- the more readily will the allocation of resources come about through the incentives and disincentives provided by the market-price system. If prices were controlled when demand or supplv falls, the excess demand could be suppressed only by direct allocation of the scarce supply through rationing the limited supph among potential buyers. \'\'hen, however, the price of a scarce commoditv or factor does rise, the price increase in itself performs the rationing function. Onlv buyers who place the higher value on the commoditv or factor will exercise their demand. Other buyers who have a lower valuation of the commoditv or factor will leave the market. While the price rise does reduce the quantity demanded to the smaller a\ailable supply, it may do so bv eliminating buyers who can no longer afford to pay the higher price, as well as some buyers who may now prefer a lower-priced substitute. \'\'hen low-income buyers are squeezed out of the market, the government mm believe that to provide an equitable distribution of the commodity, a direct form of rationing may be preferable to rationing via a price rise. But to the extent that price is not allowed to ref1ect the relative scarcity value of the commodit\', some governmental intervention in the market will be necessary to deal with the market shortage of the commodit\'. The costs of this intervention must be recognized: administrative costs, possible costs of corruption, and the costs of inefficient resource allocation. These costs must be weighted against the objective of equit\·. The phenomenon of a market shortage is common in developing countries. Recourse to price ceilings, especially for foodstuffs and primarv products, is common. In another market, the maintenance of an overvalued foreign exchange rate has also caused the government to ration scarce foreign exchange by exchange licences or the imposition of tariffs and quantitative restrictions on imports. Instead of allowing the domestic currency to depreciate in terms oftoreign exchange, the goYernment resorts to direct specific controls to reduce the quantity demanded of foreign exchange. Again, this type of price distortion operates against the efftcient allocation of resources as between import-substitute commodities and exports of non-tradable goods.

24

G!'mld ,\/. .1/Pitr

At the same time as a price increase rations a scarce commodity, it may also stimulate an increase in supply. Higher-cost producers may now enter the market. The higher price may also induce other firms to increase their investment and scale of production. For example, an increase in energy prices relates to both the rationing function of prices and the mobilization function of prices by inducing more exploration for energy sources and more investment. Finally, because the price of a product is the sum of the costs of inputs that produce the output, prices influence the distribution of income. The costs are wages to labour, rent to landowners, interest to owners of capital, and profits to entrepreneurs. Changes in income distribution among the owners of these resources are therefore determined by change in prices. This distribution is the functional distribution of income. Beyond the functional distribution, however, the distribution of income among households or income groups will be determined by prices in other ways. One way is through the choice of technique in producing a given output- for example, whether to use a higher or lower labour-capital ratio to produce a given output. The cost oflabour relative to the cost of capital equipment will determine the choice of technique when there is some substitutability between labour and equipment. A more labour-intensive technique will clearlv aid the distribution of income in favour oflabour. Another income distribution effect is related to the composition and volume of total output as determined by the pattern of demand. The impact on agricultural output is especially important because a large proportion of the population is in the rural sector, and the m>ivate Fntnjnise m Drorlojnnrnt

31

squeezed, policy implementation is erratic, or the middleman is held responsible for policy failures. The loss is the absence of competitive traders in search of marketing opportunities for new commodities or greater volumes. Such information is required by farmers, but government traders seldom reach farmers at all, much less with this type of information. Onlv a competitive, dynamic, private trading sector has demonstrated much capacity to establish this link. Although economists can make out a case for some degree of market intervention to stabilize short-nm food prices, provided there is sufficient flexibility to allow domestic prices to reflect international price trends, it must not be forgotten that price stabilization incurs the costs of public resources and also destabilizes either the government budget or the credit market. Failure to face these costs is the most common reason for failure of stabilization programmes.' Turning to foreign trade we should note that in many developing countries the foreign trade sector has experienced the greatest degree of policy reform and liberalization. Singapore shared such experience early on, and Malavsia, Indonesia, and especially Thailand have increasingly recognized the value of trade liberalization. But the Philippines has lagged in instituting such reforms, to the consequent detriment of its growth rate. The East Asian newly industrializing countries (NICs) led the wav in achieving the benefits of export-promotion and in demonstrating appropriate policies to move from import-substitution to exportpromotion. Their stories have been written many times. Suffice it here to reemphasize how verv significant it was that the governments of the Asian NICs left the import-substitution strategy at an early stage and adopted instead policies to promote exports, with considerable attention to the role that private enterprise can play in increasing a country's exports. Although there are some logical economic arguments for import-substitution industrialization, rarely has a government pursued import-substitution policies in accord vvith these arguments, let alone applied these policies in a technically correct fashion. In contrast, protection in practice has been adopted for reasons best explained through a political economv perspective. Trade policy in a developing country is placed on the agenda as a pressing problem. Balance of payments crises and the foreign exchange constraint require the state to take some action. This pressing problem of the balance of payments becomes also a pri,·ileged problem in the sense of gaining the attention of the policy-maker because it is reinforced by the ideology of nationalism and the appeal of economic independence. In a newlv emerging countrv, the economics of development may initially be an economics of discontent as the politically independent government, seeking to overcome its colonial legacy, is attracted to the values of modernization and to the correlative policy of "industrialization from the top downward". Another interpretation would have governments respond to the political demands ofvarious interest groups. In some countries import-substitution has been promoted by a development coalition composed of industrialists, urban wage earners, bureaucrats, and intellectuals. Interest groups desire to obtain politically created rents. Under these circumstances, favour-seeking flourishes, and the trade system tends to be highly distorted.

32

GE'rald 1\;[. Afrirr

From many empirical studies it is evident that in most countries a strategy of import-substitution has not been pursued according to systematic economic criteria but instead has been adopted in a chaotic, inefficient manner and for too long a time. At the micro level, too many plants have produced too small an output; quality has been inferior; capital has been underutilized; and the industrial structure has become increasingly oligopolistic or monopolistic. Few, if any, firms have been able to realize the object of Krugman's "protection as export-promotion": the scale advantage of greater production that might be provided by protection did not succeed in moving oligopolistic firms down the learning curve to lower marginal costs and hence to the eventual realization of higher profits by establishing a competitive position in export markets (Krugman 1984). The adverse effects of import-substitution have been documented in detail for numerous countries. In contrast to the dismal performance of those countries that overdid the importsubstitution strategy, developing countries that adopt an export-promoting strategy can realize higher rates of increase in per capita income. They can also demonstrate superior performance in terms of increases in saving ratios, investment ratios, total factor productivity, employment, real wages, a declining incremental capital-output ratio, a more equitable distribution of income, and better adjustment to external shocks. Why can export-promotion have such a strong favourable impact on development? As for the effect on the balance of payments, one might think that there is little difference between earning a unit of foreign exchange tl1rough exports or saving a unit of foreign exchange through import-substitution. But the domestic resource cost of earning foreign exchange can well be less than the domestic resource cost of saving foreign exchange at the margin. Moreover, exportpromoting countries become more creditworthy, and their foreign exchange constraint is relaxed. Especially significant is tl1e fact that an export-oriented industrialization strategy results in not simply a once-for-all improvement in resource allocation according to the country's comparative advantage in international trade, but more importantly in the realization of dynamic benefits. While a reallocation of resources in conformity with comparative advantage can raise the level of income, the dynamic gains can be very important in increasing the rate of growth in income. There can also be increased capacity utilization of plant, realization of economies of scale, the creation of employment through export oflabour-intensive products, a multiplier effect that gives rise to increased demand for intermediate inputs and increased demand by consumers, and an increase in total factor productivity. Export-expansion has been shown to be positively, and import-substitution negatively, correlated with changes in total factor productivity (Nishimizu and Robinson 1984, table 5). Econometric analysis also indicates that marginal factor productivities in export-oriented industries are significantly higher than those in the non-export-oriented industries (Feder 1982). The difference seems to derive, in part, from intersectoral beneficial externalities generated by the export sector. Most important can be a realization of dynamic efficiency in the sense of a fall in the incremental capital-output ratio, the realization of "X-efficiency", the

Private EntNprise in Development

extension of informational efficiency, enjoyment of external economies, and the realization of Verdoon effects. Considering the latter, there is evidence that the faster export output grows, the faster is the growth in productivitv. This is because of economies of scale, higher investment embodying capital of a more productiw vintage, and a faster pace of innovation in products and processes (Amsden 1985). More generally, dynamic efficiency may be interpreted as a reduction in what Mvint (1987) terms "organizational dualism". The improved effectiveness of the domestic economic organization allows the developing country to take advantage of available external economic opportunities in the form of international trade, foreign investment, technological adaptation. and adoption of ideas from abroad. There is institutional adaptation to realize the potential comparative advantage in trade. The mutual interaction between economic policies and economic institutions results in improvement of the organization of production, more effective incentives, and a strengthening of markets. Dynamic efficiency is achieved as the diseconomies of a small economy are overcome, the transformation capacity of the economy widens, and the learning rate of the economy accelerates. The superior development performance of countries that follow export-oriented industrialization can be attributed to these indirect dynamic benefits from trade that extend far beyond simply the direct static gains from a removal of distortions (ibid.). The essential conclusion is that whereas proponents of the old export pessimism could criticize neo-classical trade theory and assert that the dynamic gains from import-substitution industrialization (lSI) would outweigh the possible static costs of protection, it is now realized that the dynamic gains are actually far superior tale Investmml in ;\SEAN

45

The conceptofiTA has been pursued more on the basis of historical ties among countries involved than on purely economic benefits. Yet what this means is that existing barriers imposed on a most-favoured-nation basis have not been forging full trade potentials, thus necessitating an ITA. One immediate effect of an ITA even if implemented in a specified time frame (as in the U.S.-Canada case) has been to change the flow of investments towards a configuration of a homogeneous market. This in turn has been reshaping global movements of investments. A perception implied by the formation of ITAs is that they worsen the scale of protectionism for while they promote free trade among countries in the ITA, they retain their individual barriers against the rest of the world.:1 The momentum of expanding Pacific trade and the increasing magnitudes of DFI in the region (spawned by the interaction between them) may cushion the effect of these major developments. There are also a number of individual developments with far-reaching consequences. There is the continuing importance of policies pursued individuallv by the United States and japan and the need for greater co-ordination, along with the rest of the developed \mrld. There is the emergence of the NIEs (located in the Pacific area) and their implications on global trade relations. There is the distortion caused by currencv rigidities and the effects of realignments on patterns of trade and investments. There is the new openness among countries that have traditionally been closed (for example, the Soviet Union and Vietnam). There is also a movement and reaffirmation of the driving force of the private sector among the ASEAN countries. In this connection many of the ASEAN countries have embarked on systematic mechanisms for greater private-sector roles -privatization of government corporations, transfer of some public functions to the private sector, deregulation of protected sectors, and liberalization of financial ;mel trade areas. It is clear that as the ASEAN countries encourage the more active participation of the private sector, limits to an economy's absorption will be called Into question. These recent developments have positive and negative effects on the flows of trade and investments in ASEAN. V\'hile the magnitudes suggest increases, and continuing increases, as acljustrnents from these developments are still to take place, there are also prospects that may lead to declines. The net effects are still to settle down as these developments further unfC>ld. Of major importance to all these is the emerging role of the private sector. There is a push for more DFI and as this takes place, associated with the changes in trade flows, it is imperative to examine ASEAN's policy framework. Limits to ASEAN's Response The recent developments, described in the previous section, altered and will alter the flows of trade and investments within ASEAN and between it and the rest of the world. How accommodative the ASEAN countries can be to the results of these developments will also set the limits to the region's response. The supply side of accommodation hinges on the shape of the global trading

46

Florian A. Al!Juro

system and the fit of ASEAi\J in it. If the notion of the "flying-geese" pattern of trade is valid and any indication of dynamic division of labour and comparative advantage, then it would seem that one can predict the scale of trade flows in the region. For example, for unskilled-labour-intensive goods, South Korea, Taiwan, and Hong Kong are showing declines in their revealed comparative advantage indices at their levels of per capita gross domestic product (GDP) (Naya et al. 1989). On the other hand, where policies are not accommodative of this pattern, the scale of supply may not be that predictable. Significant divergence in AS~'\J's economic policies are unlikely to foster a stable supply response either. For example, where exchange rates are kept overvalued, the effects ofliberalization would simply be washed by varving monetary policies. The point here is to ensure policy harmonization among ASEAN. The physical limits of infrastructure and other facilities set an absolute response rate for A_'SEAN. The need for physical space, telecommunication, ports, power, and other infrastructure requires a time frame for building which mav not be consistent with market requirements. \\'here capacities have been reached, absorbing further private investments may encounter increasing costs and declining competitiveness. The tendency for DFI to locate where facilities are readily available easily stretches the limits. Not only will incremental public investments require planning and a gestation period, but accommodation also puts undue claim on buclgetarv resources and lead to more skewed clen:lopment patterns exacerbating problems of benefit incidence. For one, since DFI locates where facilities are, once limits are reached a public investment response will require a large outlay displacing alternative public investments elsewhere. For another, such budgetary response will highlight greater disparities between areas where facilities are available (which capacities have been strained clue to DFI) and where they are lacking. For countries such as Thailand, Indonesia, and the Philippines, this exacerbates urban-rural disparities. v\'hether or not incentives stimulate a supply response is now beginning to reappear as debatable. More accuratelv, there is a question of whether increasing incentives stimulate an increase in DFI. It is argued, as in the study by Guisinger in Chapter 6 of this volume, that while there are competing and similar incentives across countries, foreign imestors responded that they would not have located where they were if incentives were withdrawn. Put differently, an increase in incentives may not yield an incremental benefit but a withdrawal, where other countries which have incentives \viii not follow, is likely to reduce inflows (Guisinger 1986). It is difficult to isolate the effects of individual incentive instruments especially where they are simultaneously pursued, and there are many differentially affecting revenues, inputs, and components of value added. These are generally classified as commodity-based or factor-based incentives. In most cases, they have cumulative and interacting effects and therefore it is perhaps more u-actable to consider the effects of a whole incentives regime, not its individual components.~ In any case, the recent surge ofDFI in the AS~'i countries, especially Thailand,

New

N~eds

and Polin Fram fworhfor P•·ivali' Jn w stmenl in ASr:AN

47

Malaysia, and Indonesia, indicates a combination of these as limiting the ASEA.~ response to production and trade. Despite the provision of incremental incentives the limirjng factor for Thailand has been pressure on its avai lable infrastructure (Tan 1989). Even though it is difficult to sort out from among these factors which are the ones that constrain ASEA>.'I's response, this is important to examine the region 's policy framework. As DFI expands in the region there is a need to determine how private investments can participate in the process of public response to them. At thisjuncture among the ASEA>.'\J countries this is especially critical given competing claims on government resources, and development objective s of broader development impact and equity in the distribution of gains. It is not so much to increase co-operation in A5E.A.'\i, .t since DFI will be determined by microeconomic ply alternative pattern of response. In the context of the product cycle, a country mav move up the ladder in tenus of goods produced and traded without necessarilv relocating factories or 'lCCommodating new ones. 2. This really means intra-PECC trade or exchange among the Pacitlc countries. 3. The possibilit:v of trade diversion would be minimized if simultaneous with the formation of ITA there is a reduction in barriers on a multilateral setting. The rationate for the ITA then becomes one of capturing benefits earlier among member countries. 4. It is also to be mentioned that other macroeconomic factors also influence DFI. 5. There is no regional (.\.SEAl\') policy to speak of that is affecting DFI in the region. There are, however, efforts to promo!5 1S.55 IS .55

* Concessional ratt>s given for premises with two or more households. "With dft>ct from 1 May 19S3. "With efli:'ct fi·om I Nowmbcr 19S5. 'With dkct from I August 19S7. Sot•Rt:t.: l'ublir· U!ililin Bowd Anmull Ht'jmd.\ (variom years). ~

TABLE 4.5 Gas Tariff, 1978-87 (In cents/unit) 1978

Year

1979

Fuel acljustment General 1-15,000 >15,000 >50,000 Flat

4 3.5 3.25

1980

1982

1981

5.02

3.19

3.19

3.19

9.02 8.52 8.27

12.21 11.71 lUG

12.21 1 I .71 11.4()

12.21 I 1.7I 11.46

1983

1984

1.21

1.21

10.21

10.21

19.'l!'> ,,

10

198()

1987

8.3

8.3

7.3'

7.3'

6.8 1'

6.8 1

Bulk A

Flat Minimum charge (S$)

3.25 1,625

8.27 1,625

11.46 1,625

27.55 1,625

27.11 1,625

Flat Minimum charge (S$)

3 6,000

8.02 6,000

11.21 6,000

11.21 6,000

11.21 6,000

3

8.02 7.02 15,000

11.21 10.21 15,000

11.21 10.21 15,000

11.21 10.2I 15,000

9.21

1 '

9.21

9"

j,

B

c 1-500,000

>500,000 Minimum charge (S$)

2 15,000 -

-

-

-

"With effect from 1 November 1985. "Minimum consumption 50,000 units. ' Minimum consumption I ,000 units. SouRcE: Pu/Jlic Utilities Board A nmwl RJ.'f)()r/s (various years).

---

--

-

-

--

--

-

-

-

-

--

--

---

-

-

--

:f.

"':2.

E:

"

:Jq

;p "'::-:" "r-o

TABLE 4.6 Water Tariff, 1978-87 (In cents/cu. metre) ----

----

Year

-----

1978* --------

Domestic 1-20 l-2S 20-40 25-50 >40 !J0-7S >7!J Non-domestic l-5,000 >5,000 Flat

1979* - -

30

30

30

40

40

40

50 6()

so

!)()

66

66

(j(j

RCI·:

:;:

---

1981

1982

1983

1984

1985

1986

1987

35

35

42

42

42

53

S3

45

4S

57

57

S7

7S

7S

7S

7S

95

95

9S

110

75 85

75 85

95

9!J

9S

1I 0

110

I I0

--

66

* Concession a! rates given for premises with Sm

----

1980*

;::::-~

::-: ;:,-.

66

110

110

two or more households.

Publir Utilities Board An mud Rt1JOrts (various years).

Ol

'-''

66

Lim Chin and Linda Low

TABLE 4.7 Capital Expenditure, 1978-87 (In millionS$) Electricity -·~-----

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

Gas

\'Vater

Services

- - -

391.2 116.4 I 74.7 162.3 510.1 360.0 286.0 598.6 691.8 522.3

Total -----

8.4 7.7 6.9 8.0 6.0 7.6 5.5 5.6 ll.2 8.6

39.9 41.3 36.3 49.2 45.0 99.9 220.6 228.6 114.7 31.0

2.1 2.7 5.8 2.8 6.2 16.2 16.2 16.1 11.0 13.9

441.6 168.1 223.7 222.3 567.3 483.7 528.3 848.9 828.7 575.8

------

SocRCE: Public Utilities Board Annual Reports (various years).

decision regarding the PUB's privatization, making it the first statutory board to be declared privatizable (Straits Times, 8 Aprill989). However, as also noted by the PSDC, only electricity and gas are involved, but not water, for strategic reasons. There is also one wholly owned subsidiary, the Development Resources Pte. Ltd., incorporated to provide electrical consultancy, contracting, and engineering services for power station projects which may have to be privatized along with the Electricity Department. The stated rationale for PUB's privatization is to have greater flexibility in managing its activities and in serving consumers' needs. But as it will remain a monopoly, the new company will be regulated like the other statutory boards which haw~ been privatized, such as the Singapore Mass Rapid Transit (SMRT). Privatization will none the less not take place for another five years for three reasons. One is the large sum ofS$10 billion worth of PUB assets which cannot be off-loaded in the stock market in a hurry even though the government is expected to retain a major share. Second, the government's negotiations with Malaysia over the joint purchase of natural gas and water from Johor is still under way and that must be settled before privatization can take place. Third, the government has expressed the desire to privatize statutory boards one by one in an orderly manner. Thus, it may be possible that another statutory board, such as Singapore Telecom for instance, is ready for privatization before the PUB is (Toh and Low 1989). On the question of what is privatizable, it is generally accepted elsewhere that the generation of electricity should be privatized and subject to competition, but not the transmission and distribution of electricity (see also Sunday Times, 1January 1989). The established arguments are that the transmission and distribution network has scale economies and it is inefficient to have competing companies setting up a duplicating network. Power generation, however, is not natural monopoly and could be efficiently produced with more competition. This

;p g

f!·

~-

;p "'~"

r--

~

~

TABLE 4.8 Revenue and Rate of Return on Fixed Assets of the PUB, 197H-87

c;

---

Rate of Return(%)

Net Revenue (millionS$)

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987

PUB

Elcctricitv

Gas

Water

Electricity

Gas

Water

109.2 118.8 149.5 179.6 175.6 192.1 214.5 294.9 368.2 476.2

66.8 76.4 115.1 141.4 128.5 138.6 167.0 247.5 306.0 387.8

7.2 7.0 4.5 9.2 8.5 7.4 8.5 9.8 13.1 11.3

35.2 35.4 29.9 29.0 38.6 46.1 39.0 37.6 49.1 77.1

4.2 3.4 5.2 5.6 4.3 4.3 3.4 5.9 7.0 7.5

7.7 7.0 7.1 9.0 8.5 7.0 8.1 8.7 11.3 10.8

7.7 7.3 6.0 5.4 4.3 5.9 3.9 3.3 4.1 5.9

--------

Sou ReF: Publir Utilities Board Annual RRj}()rfs (various years); Richard Lee ( 1990).

_,

0";

Ol 'X

TABLE4.9 Sales Revenue and Cost per Unit Sold, 197R-R7 (In cents) --

·-

- ·

Electricity

- · - · ·

Gas

Water

10.0 10.9 16.0 1R.7 1R.4 17.5 17.2 17.2 12.R 13.4

Electricity

·-·

6.0 7.3 10.7 11.4 10.7 9.9 9.6 9.6 R.1 R.1

- - . -

--

45.0 54.1 44.7 46.7 52.4 52.7 65.3 63.2 65.4 71.6

- · -

- - - - - - - -

Gas

8.R 9.6 14.1 16.6 16.5 15.7 15.2 14.7 9.8 9.9

--

Sot w :t·:: Public Utilities Board Annual Iuports (various years).

--

4.R 6.2 10.1 9.R 9.3 R.6 8.2 R.7 6.4 6.3 -·

-

--

Net Sales Revenue per Unit Sold

Cost per Unit Sold

- - · -

197R 1979 19RO 19R1 19R2 19R3 19R4 19R5 l9R6 19R7

---

·--

--

-

Sales Revenue pPr Unit Sold

Water

-

-

Electricity

Gas

vVater

1.2 1.3 1.9 2.1 1.9 LR 2.0 2.5 3.0 3.5

1.2

15.7 23.9 11.7 0.2 13.0 14.6 11.8 10. I 12.3 21.7

- - - ·

29.3 30.2 33.0 36.5 39.4 3R.I 53.5 53.1 53.1 49.9

l.l

0.6 1.6

1.4 1.3 1.4 0.9 1.7 1.8

t

;;; ()

"'" ;;;· "'"'-

"'t-
ev;un \o \w_ v:,'wen \o \n\" conce-p\ o\: "ro\\'\n~ "Da_c\ili(Jte lnveslmrnl: Technical A.ssistana

investment-generation (1988, chap. 2). Wells and Wint also concluded that investment marketing, as distinct from investment incentives and government services as defined in this essay, was cost-effective. They found the benefits created by one such programme in Costa Rica were more than three times the cost of the programme (ibid., p. 173). 6

Conclusion and Policy Implications All governments seek to streamline their operations and investment promotion is no exception. To improve the efficiency of their investment-promotion efforb. governments would like answers to a number of questions: 1. Are all incentive instruments equally effective? 2. Will a change in the mix of policy instruments achieve the same incentin· effect at a lower revenue cost? 3. Is our current balance between incentives and disincentives sufficient to attract the desired level of investment? 4. Is investment marketing more cost-effective than investment incentives in stimulating investment? Unfortunately, the available empirical research does not provide clear answers to these questions. Virtually all of the research to date on incentive effectiveness suffers from specification error: statistical models have excluded important variables and included incomplete or incorrect variables. We are at that early stage in the research life-cycle where definitions are unclear, data are lacking, analytical methods are mdimentary, and those with strongly held convictions prevail over those awaiting scientific confirmation. How then can we move to the next stage of the cycle? We need to standardize the definitions for the instruments of investment promotion. This is not an eas~ task for it is fraught with the same controversies that have prevented agreement on which government subsidies produce distortions in international trade. This chapter has suggested a tripartite division of investment promotion into three mutually exclusive categories: investor-related government services, investment incentives, and investment marketing. But further standardization on the content of each of these categories must take place (Does the term "incentives" include disincentives? Are incentives limited only to policy variables?). Also, if we are to explore cause-and-effect relationships between investmentpromotion methods and investment, then we must devise better ways of measuring the magnitude of the cause. In the analysis of investment incentives, for example, the statutory tax rate or the number of years of a tax holiday cannot continue to be used as measures of government incentives when other incentive policies are present. Investment incentives lack the transparent and widely accepted measure that the concept of effective protection provides the study of trade barriers. Elsewhere, I have proposed a new measure called total protection that integrates trade and domestic interventions into a single measure with an investment's rate

106

Stephen GuisingPr

of return as the numiraire, but empirical research on quantifying the net incentive is still in its infancy (Guisinger 1989). Better· measures "'ill enable researchers to assess the relative effectiveness of different approaches to investment promotion, permitting governments to shift their budget allocations towards more effective measures. Government~ will also be in a much better position to judge each incentive's contribution to the total net incentive as well as its cost. With this knowledge, governments can frame efficient strategies for investment promotion. Better measures will also help them determine if agreements to limit the level of incentives (and perhaps even government services and investment-marketing expenditures) are in their interest. The analysis of investment-promotion policies is about where tariff policy analysis was two decades ago. Much more carefully crafted empirical research is required before we can begin to answer such a simple question as: Does investment promotion work?

1\0TES *The author would like to thank Louis T. v\'ells,.Jr. and 'William Bradberry for their useful suggestions on an earlier draft. I. Two different positions on the clisincentiYe effects of corporate income taxation are possible. One position is that only the excess corporate tax above some normal bench-mark is a disincentive since all factors must bear some taxation to support government expenditures. The second position is that from a free-trade standpoint anv tax is a disincentive. See Bond and Guisinger ( 1985) for a discussion of the bench-mark issue. 2. Reuber's use of the comparative form in this sentence is puzzling. Compared with what? Other policies or other economic factors? Atom bombs can be relatively ineffective compared with hydrogen bombs but still be "of some consequence'. 3. A fourth, automatic policies, is not relevant here. 4. Assignment of promotion ancc regulation authoritv to a single state corporation would be centralization under the Encarnation and V\1ells taxonomy. 5. Bradberry ( 1986) contains an interesting discussion of investor preference and uses survev data to show the absence of indifference for incentives with the same ostensible financial value. Bradberry also provides additional evidence supporting the effectiveness ofinccnti,·es in altering the location decisions oftirms. 6. In his comments on a previous draft ofthis paper, Wells notes that Costa Rica may well represent an efficient programme and a similar calculation for another country, sav Indonesia, might reveal low economic returns from investment marketing.

REFERE~CES

Blais, Andre. A Political Sociolo!,')' rfPublir Aid to Industry. Toronto: University ofToronto Press, 19f\6. Bond, Eric and Stephen Guisinger. "Investment Incentives as Tariff Substitutes: A Comprehensive Measure of Protection". Rruirw of Economics and Statistics LXVU, I (Februarv 19H5): 91-97. Boskin, Michaelj. "Tax Policy and Economic Growth: Lessons from the 1980s".juurnal ofr:Conornic Perspertivrs2, no. 4 (Fall 19SH): 71-97. Bradberry, William. "U.S. Multinational Corporate Managers' Response to Investmt>nt Incentives and Performance Requirements". Ph,D. dissertation, School of Management, Universitv of Texas at Dallas, 1986. Encarnation, D. and Louis T. Wells, Jr. "Competitive Strategies in Global Industries: A View from

Pmmotion of Private Investment: Technical Assista nee

107

Host Governments". In Competition in Global Industries, edited by Michael E. Porter. Cambridge. MA: Haryard Business School Press, 1986. Gruben, Barn· and john Mutti. "Taxes, Tariff5 and Transfer Pricing in Multinational Corporation Decision Making". Mimeographed. 1989. Guisinger, Stephen. "A Comparative Study of Country Policies". In Guisinger and Associates 198c,_ ____ .'Total Protection: A New Measure of the Impact of Government Interventions on Investnwnt Protitability" . .fuurnal of International Business Studies, Summer 1989. Guisinger, Stephen and Associates. Investment Incentives and Performance Requirements. :\lew York: Praeger, 1985. Hughes, H. and G. Dorrance. "Foreign Investment in East Asia". In Deve0ping withForri!!:" lnvestmml. edited by Vincent Cable and Bishnodat Persaud. London: Croom Helm, 1987. Kerdpibule, L'dom and E. D. Rams tetter. "Foreign Investment Theories and Policy Issues". In Dint/ Forei!!:" Investment and Expurt Promotion: Policies and Fxperirnces o[Asia, edited by N aya, Seiji, V. \ "ich itVadakean, and Udom Kerdpibule. Honolulu: East-West Center, 1988. King, Menyn A. and Don Fullerton. The Taxation of In rome from Capital: A Comparative Stud1 of the United Stales, the United Kingdom, Sweden and West Germany. Chicago: Cniversity of Chicago Pre>'. 1984. :\iaya, S., K.S. Sandhu, M. Plummer, and N. Akrasanee. ASEAN-U.S. Initiative: Assessment and Reromrnendationsfiir Improved },'conmnic Relations. Singapore and Honolulu: Institute of Southea't Asian Studies and East-West Center, 1989. Reuber. Grant. Private Foreign Investrnrnt in D!'(!eiupment. Oxford: Oxf(Jrd Cniversitv Press, 197:1. Root, Franklin and A.A. Ahmed. "The Influence of PolicY Instruments on Manufacturing Direct Foreign Investment in Developing Countries" . .fuum.al of Intnnational Business Studies 9, no. :1 (Winter 1978): 81-93. Snape, Richard H. "Export Promoting Subsidies and \\'hat to Do about Them". Washington. DC: World Bank, September 1988. Usher, Dan. "The Economics of Tax Incentives to Encourage Investment in Less Developed Countries". Journal of Development Economics. 4 (1977): 119-48. Wallace, Cynthia Dav. "Foreign Direct Investment in the Third World: C.S. Corporations anrl Government Policy". In Foreign Direct Investment in the 1990s: A New Climate in the 17!ird World, edited by C. D. Wallace. Demer: Westview, 1989. Wells, Louis T.,Jr. and A. G. Wint. "Marketing a Country: Promotion as a Tool for Attracting Foreign Investment". Mimeographed. 1988.

108

Stephrn Guisingn

APPENDIX TABLE A6.1 Incentives and Disincentives -----------------

Mfecting Retums Tariffs Differential sales and excise taxes Export taxes or subsidies Quotas Export minimums* Price controls (or exemption from) Multiple exchange rates Undervaluation/overvaluation of currency Government procurement preferences Production or capacity controls Guarantees against government competition Prior import deposits Transfer pricing restrictions Mfecting Inputs Tariffs Differential sales taxes and excise taxes Export taxes or subsidies Quotas Price controls Multiple exchange rates Undervaluation/ overvaluation of currency Subsidized purchases or required purchases from public-sector suppliers Local-content requirements* Prior import deposits Transfer pricing restrictions Limits on royalties, fees Ylultiple deductions permitted in tax accounting Cash or in-kind grants for R&D Mfecting Components of Value Added Capital Goods

Cash grant Tax credits Investment allowances Subsidized leasing Tariff/sales tax exemption on imported/domestic equipment Prior import deposits Local-content requirement for capital equipment Limits on use of used equipment Subsidized buildings Subsidized cost of moving capital equipment

-

Promotion of Privatr Investment: Terhniral Assistance

APPENDIX TABLE A6.1 (continued)

Cost of Debt Subsidized loans Loan guarantees Subsidized covering offoreign exchange risks on foreign loans Priority of access to capital markets

Cost ofEquity Subsidized equity purchases by public investment agencies Selective exemption from capital gains and registration taxes Dividend tax (or selective exemption therefrom) Guarantee against expropriation Limitation of debt/ equity ratio Controls on remitted dividends Minimum ration of financial to in-kind capital contributions

Corporate Tax Tax holiday or reductions Accelerated depreciation Special deductions and valuation practices (e.g., inflation accounting) Tax sparing and double-taxation agreements Loss carry-fonvard provisions Contractual stabilization of rates over time

Labour Wage subsidies Training grants Minimum wage regulations Selective relaxation of industrial relations laws Local labour requirements* Severance payments

Land Cash subsidy to purchase or rent Exemption of property taxes

Not Classified Limitations on foreign ownership* Free-trade zones General pre-investment assistance Countertrade requirements* Offset requirements* Foreign exchange balancing requirements* World product mandate* Geographical location within host country TechnolO!,'Y sharing* NoTE: Asterisks indicate performance requirements. SovRcF.: Guisinger and Associates ( 1985, table 1.1).

1m1

7

Promotion of Private Investment: Institutional and Legal Infrastructures Djisman S. Simandjuntak

Arguments for Continuous Promotion In the vast terrain of developing countries, the economies of the A~sociation of Southeast Asian Nations (ASEAN) are often referred to as an oasis of favourable investment climate. Unlike Latin American countries where private investors were, until recently, severely criticized for ha\ing collaborated to exploit workers and, therebv, led their respective country to a "development of underdevelopment", as in the vocabulary of dependPncia, the ASEAN countries have maintained an accomodative stance towards private investment, at least since the late 1960s. Admittecllv, private investment in the ASEAN countries has also been subject to restrictive regulations. \Vithout an adequate economic explanation, different rules mav be imposed on different sectors of the economy. Banking in Indonesia, f()r example, is freely open to new entrants from the private sector, including foreign bankers through joint ventures, as of October 1988, but telecommunication is not. Friendliness towards private investors also fluctuated over time, depending on changing circumstances. Onlv five months after the enactment of a foreign investment law, the Government of Indonesia nationalized in February 1959 Dutch companies which were partly returned or properly compensated seven years later when the New Order government announced a new invesunent policy which was much more accomodative to foreign investment (Himawan 1980). Seven years later, the New Order's investment poliC\· experienced an erosion when the government was forced to respond to a political riot that had Japanese investment (including joint ventures with Indonesians) among its targets of criticisms. Following the near-collapse of the international oil market in the 1980s and the hardship it caused in terms of a dramatic decline in export earning and budget revenue, a series of investment-related liberalization initiatives have been announced by the same government. 1 Less than three years after the announcement of the first policy package in 1986, severe criticisms against certain elements of the liberalization initiatives of the 1980s were again launched by different circles, forcing the government to first slow down the speed offurthe1 liberalization and to introduce regulatory measures that may help tone down criticisms against the new policy direction. Similar fluctuations can also be observed in the investment policies of the other

Promotion uf Private Investment: Institutional and I ,egal Infrastmcltnes A~EAt'\'

Ill

countries (see, for instance, Crone 19Rl). Even Singapore ha~ its mm reason

to impose certain regulatory elements in its investment policy and to withdra\\·

some of these elements under different circumstances, as clearlv reflected in its policy response to the recession ofthe mid-1980s. Indeed, economic regulation. including investment regulation, is said to fluctuate along a long cycle \rith a restrictive posture at a time of depression and vice versa. 2 Such fluctuations han· far-reaching implications for the shaping of institutional and legal infrastructures of investment promotion. Despite the fluctuations outlined earlier, investment policies in the ASE \:\ countries have been characterized by a high degree of realism over a relatin·h long period. Since the end of the 1960s, the regulation of private investment in ASEAN has never taken an extremely restrictive posture. The result of this pragmatic course is ref1ected in a relatively high level of investment in the ASEA.l\1 countries, as can be seen from Table 7.1 which, admittedly, does not accuratelv show the level and changes in private investments. However, the substraction of government capital expenditure from the data in Table 7.1 will result in private investment which is high in terms of volume and encouraging in terms of increases from year to year. The ASEAN countries seem to have fared quite well in attracting foreign investments other than official capital, as can be seen from Table 7.2. New inflm1 did slow down in the mid-1980s, but it has clearly rebounded since 1987 as a combined result of adjustment policies on the side of the ASEAN countries and changed circumstances in the Pacific economies, especially those of Japan and the newly industrializing countries (NICs) ofEastAsia. The increa~e was particularlv strong in the case of Thailand, which indeed can now afford to be more choosv with respect to foreign investment projects with its changed development priorities. With all the political troubles, the Philippines had also managed to attract nearlv 700 million special drawing rights (SDR~) in 1988. Though less impressive in terms TABLE 7.1 Gross Capital Formation as a Fraction ofGDP (In percentages)

Indonesia Malavsia Philippines Singapore Thailand Memorandum South Korea japan

1982

1985

1987

27.9 37.3 25.3 47.5

26.3 25.5 15.1 36.2

23.4

26.5 27.6 14.7 42.2 23.7

29.3 29.7

29.7 27.7

30.7 28 9

225

Sm·RcE: International \1onctarv Fund, TntPm.ational Finanrial Statistics (various vears).

Djisman S. Simamlj'untak

112

TABLE 7.2 Inflow of Foreign Direct Investment to ASEAN (In million SDRs)

1982 Indonesia Malavsia Philippines Singapore Thailand Share of ASEAN in world total, %

205 1,266 14 1,451 175 6.4

1986

1987

1988

221 417 108 555 225

337 327 237 975 271

404 483 696 968 832

2.4

2.5

3.4

Sm.·RcE: International Monetary Fund, Balance of Payments Statistics Yrarbook 1989.

of actual inflow in 1988, foreign direct investment (FDI) has exhibited a strong recovery in Indonesia in spite of the fundamental change in orientation away from domestic demand-based investment to an export-based one. Similar rebound has also taken place in Malaysia and Singapore. On top ofFDI, the ASEAN countries have also enjoyed a sizeable inflow of portfolio investment. Even Indonesia, which lags furthest behind among the ASEAN countries in terms of stock exchange, has experienced a "boom" in portfolio investment. The pessimistic picture drawn in the mid-l980s of the prospect for investment in ASEAN has proved to be an exaggeration. The encouraging development of private investrnen ts in ASEAN in the last three years cannot obscure the need for continuous promotion. The following discussion will demonstrate in a concise way the different forces that call for an active investment-promotion programme rather than a passive one. Commonalities do exist in some respects, but differences seem also to have widened in certain aspect~ of investment promotion in accordance with the different stages of development of each of the ASEAN countries. One of the obvious reasons for the promotion of private investments relate to the public sector's indebtedness and the payment obligations arising therefrom. This is particularly true in the case of Indonesia and the Philippines, as can be inferred from Table 7.3. Repayment burden in the case of the Philippines is in fact only partially reflected in Table 7.3 in view of the repeated reschedulings of debt payments this country has gone through over the last few years. In addition to the repayment, there is interest payment. With debt burden of the size both Indonesia and the Philippines have to shoulder, government finance is bound to be tightly constrained with little resources left for the financing of investment. Even in the area of infrastructure, which determines to a great extent the sustainability of the current recovery, efforts need to be taken to secure the involvement of the private sector in the construction, financing, and running of certain projects. Indonesia has started to do this, though in a cautious way. The Indonesian Government is involved in infrastructural development, for example,

ll ')

Promotion of Private Investmrnt: Institutional and Legal Infrastructures

TABLE 7.3 Repayments of Foreign Long-Term Loans (In million SDRs) 1981

1985

1988

Indonesia Official sector Other sectors

651 243

1,4:1:1 786

2,571 1,116

Malaysia Official sector Other sectors

70 102

147 448

284 1,062

Philippines Official sector Other sectors

223 406

114 1,299

249 1,194

Thailand Official sector Other sectors

92 n.a.

193 n.a.

270 n.a.

n.a. =Not available. SOl'RCE:

International Monetary Fund, Balance of Payments

Statistics Yearbook 1989.

the toll-road sector through a joint venture established by the state toll-road enterprise. The state monopoly in telecommunication services is also being attenuated through a profit-sharing scheme between the state telecommunication company and the private sector in certain segments of the services. Bolder steps have to be taken, in view of the "aid fatigue" that is said to have plagued major sovereign lenders and their preference for lending to the private sector. However, the private sector's engagement in very long-term investment requires greater security against unexpected changes in investment policy as well as promotional efforts on the part of the government. Restructuring goes hand-in-hand with economic growth. The time may soon come when the ASEAN countries can no longer count on the scarcity rent of natural resources, including that of beautiful landscapes as a tourism attraction, and socalled "cheap labour"while seeking comparative advantages in world trade. Future growth in A'3EAN requires diversification, sectoral as well as vertical, the speed of which in turn is determined by the extent to which technology is progressing in the economy. It is the role of private investment, especially FDI, as an agent of technological change that the ASEAN countries should pay greater attention to while pursuing their respective promotional policies. There has always been doubt about the effectiveness of FDI as an agent of technological change in the host country. A foreign company is accused of doing everything possible to prevent the transfer of its technologies to local companies, including partners of ajoint venture. There are many ways, so the argument goes,

114

Djisman S. Simandjuntak

in which a multinational corporation (MNC) can effectively hinder the transfer of its technology or even engineer a "reverse transfer" of technology.:1 On the other hand, it can be argued that a country hosting a foreign company has done too little or followed a wrong approach while trying to acquire technological capability through FDI. There are cases in which expatriates in a foreign company are limited to a very small number with the stated objective of maximizing the absorption of local workers. This policy of "nationals first" has ironically diminished the level of technology transfer to local workers. In other cases, the local partner of a joint venture may find technology transfer too cumbersome to deal with and is primarily interested in maximizing any kind of rent by seeking, for instance, the highest possible level of entry barrier. Local workers in a joint venture may also lack the qualifications needed for an effective transfer of technology. In short, barriers to technology transfer are often subconciously erected by the host countries themselves. The acquisition of technological capability is too important to be neglected any further by the ASEAN countries. Ways and means have to be found to set forth this process of acquisition as rapidly as possible. In doing so, the ASEAN countries can learn from the successful experiences of other countries such as the Asian NICs. To be successful, however, the fundamental change in attitude towards foreign investment appears to be needed. The ASEAN countries and the enterprises therein have to adapt themselves to the logic of global competition." The traditional way oflooking at foreign investment as a temporary "evil" that will be kicked out once domestic enterprises have "matured" has to be abandoned. Success in technology acquisition is increasingly dependent on the ability of a local company to forge an alliance with its foreign partner(s) ."The keyword in this connection is "co-operate in order to compete". The growing importance of alliances is clearly reflected in the rapidly increasing cases of "marriage" between competitors such as Motorolla and Toshiba, . \T&T, Olivetti and Philips, General Motors and Toyota, and many others. Countless articles, both empirical and conceptual, have been written on strategic alliances. 6 Some alliances are successful while others never took off the ground. It is therefore important to understand the factors that affect the performance of an alliance. Furthermore, governments seem to have played an important role in promoting alliances. The scanning of potential allies as done, for instance, by Singapore's Economic Development Board, which eventually brought over Apple to Singapore, is the least the private sector can expect from the government. It can never be overemphasized that an alliance requires the availability of a certain level of competence on both sides of the partnership that has to be clearly identified before it is set up. Of great importance to the future economic development of the ASEAN countries is the role offoreign investors in promoting export. International trade is likely to be increasingly patterned by what may be termed "intra-product" division oflabour, which may be seen as a deepened "intra-industry" specialization. Under this new type of specialization, trade between headquarters and their subsidiaries

Promotion of Private Investment: Institutional and Le[!;alinfrastmctures

11:)

abroad is likely to increase rapidly. Furthermore, such a specialization is a promising weapon against protectionism. A country which is extensively involved in "intraproduct" specialization has to think twice before it decides to attack import, as a decline in import is bound to hurt domestic production in industries with global sourcing of intermediate products, as in the computer industry. UnfortunatelY. some of the A.SEAN countries seem to have underestimated the importance of this new di,ision oflabour to international trade. By insisting on full manufacturing. these countries swim against the currents and are likely to be left out in a growing number of industries which happen to be the industries '-"'ith the highest growth potential. At least in the automotive, computer, aircraft, and telecommunication industries, obstacles emanating from a programme of full manufacturing are unlikely to be compensated by promotional activities. The need for investment promotion is apparent in the case of small investors. One of the problems facing most ASEAN countries today is a high len:·l of concentration in the hands of big enterprises and underdeveloped small enterp1ises in the manufacturing sector. V\'hile the population of small manufacturing enterprises is extremely large, its contribution to its gross domestic product (GDP) is very small. Problems then arise not only because of inequality, but also because of the inability of small enterprises to support the growth of large enterprises. On the other hand, potential investors from abroad are likely to consist of small- and medium-sized enterprises as the large ones have already been present in ASEAl\. These enterprises are more risk-averse than large ones and are, accordingly, more demanding in terms of security against any unexpected change in the investment policy of the host country. Finally, the competition for foreign investment is getting tougher and tougher, pointing to the need for greater promotional efforts. The reasons for this increased competition are manifold. The United States itself is one of the most attractiye locations for foreign investment, not only because of its huge domestic market, but also because of the leadership of many of its enterprises in science and technology. In fact, different state governments in the United States are competing against each other, offering all kinds of incentives to lure investments from different parts of the United States and the rest of the world, particularly Japan. China is likely to remain a strong competitor in the race for foreign investment in spite of the bloody campaign against democratization that somehow indicates the narrow room beyond which economic reformers cannot go without stirring up turmoil politically. Even the Soviet Union, the originator of the centrally planned economY, is likely to join countries vying for foreign investment. Special economic zones may soon become a reality in the Pacific part of the Soviet Union. For the time being it is safe at least to say that the attention of foreign investors is likely to be diverted to Eastern Europe, though it will be quite some while before this region can establish itself as an attractive location for foreign investment. Furthermore. Western European countries are rapidly transforming themselves into a single European market. Some of them have in fact been involved in an active promotion of investment, offering investors various incentives on top ofthe attractiveness that

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Western Europe has because of the integration of its economies. The interest in increased foreign investment is also growing in other parts of the world such as Latin America. In short, the competition for foreign investment has truly become global. The ASEAN countries may find it increasingly difficult to maintain their shares in new foreign investments in spite of the widely praised position of ASEAN as being a fast-growing region. The competition for investment is exacerbated by a growing criticism against investing abroad, especially in the United States. This kind of criticism is not new. The fear has long been expressed that investing abroad will eventually boomerang as the host country succeeds to acquire all the advantages that originally gave an investor the confidence to invest abroad. "Investment wars" will be fought, therefore, not only among host countries, but also between them and the home countries (Bergsten 1974). Indeed, some American companies seem to have discovered the merit~ of staying home or coming home. Many observers argue that manufacturing offshore is bad business. 7 If japanese manufacturers choose to locate their plants in the United States and stay competitive, so the argument goes, it must be wise for American companies to do the same. The implications of such a relocation of investment back to home countries would have far-reaching implications for developing countries. To facilitate such a movement of investment, the governments of home countries may employ different incentives. Moreover, technological progress has made it possible for some companies to reinvest in their home countries some of the industries which had earlier shifted to developing countries because oflabour cost consideration and the imperative of serving foreign markets through FDI. Given the new configuration in the world of foreign investment, the ASEAN countries have to reformulate their position in order to remain attractive in the global race for investment. In addition to the advantages rooted in the relative abundance of natural resources and labour force, they have to develop new sources of attractiveness, some of which may come from improved institutional and legal infrastructures. Sources of Policy Inconsistencies The ASEAN countries have each in its own way some ambivalences vis-ri-visprivate investments in general and foreign investments in particular, though, in general, their contribution to economic development is appreciated. While different limitations are imposed on the activities of the private sector, private investment is asked to make various contributions to the attainment of economic, social, and political goals. This ambivalence towards private investment has not been thoroughly studied. It is rooted partly in the colonial origin of the modern private sector in most of the ASEAN countries. The perception of the private sector as the economic arm of colonialism was so deeply rooted that its presence is constitutionally confined to sectors which are of marginal importance to the economic development of Indonesia, for example. However, colonialism died a long time ago as far as the

Promotion of Private Investment: Institutional and Legal Infrastmrtures

Ill

ASEAN countries are concerned. There must be other reasons for the persistence of ambivalence towards the private sector in some of these countries. Domination of the private sector by ethnic Chinese has always been among the sources of uneasy feeling about the private sector in almost all the ASEAN countries. It has far-reaching implications upon the investment policies of at least :\1alavsia and Indonesia, as reflected in Malaysia's New Economic Policy and repeated attempts by the Government oflndonesia to redistribute ownership in the private sector by inserting special measures in the investment policy in favour of indigenous Indonesians. Criticisms against the private sector in Indonesia may have softened a great deal, had the indigenous businessmen succeeded in catching up vvith ethnic Chinese businessmen. The private sector is often accused ofnarrow-mindedness in the sense that its involvement in the economy is solely based on the prospect for making a profit in the shortest possible period. In many instances this accusation is baseless ..\ plantation is a project with a long gestation period. Yet, the private sector is strongh represented in the plantation economy of the ASEAN countries. Nevertheless, it is perceived to be inferior to state enterprises in the launching and operation of big or pioneer industries, which are not clearly defined, however. This perception provides another reason for the government to regulate the private sector. The fact that state enterprises, too, do suffer from serious troubles or business failures has proved to be insufficient to demystify their alleged superiority over private enterprises. Nevertheless, the bias against private investment seems to have softent>d in the last decade. Cautious privatization has taken place or is being seriomh considered in all the ASEAN countries. It is not very clear how people in the ASEAN countries perceive foreign investment compared with domestic investment. While there is a strong tendenn among policy-makers to assume that domestic investment is better than foreign investment, it remains an open question whether or not this view is vtidely shart>d among the populations. Suffice it to point out at this juncture the tendencv of some ASEAN countries to treat foreign investment as a temporary phenomenon that will be discouraged once domestic companies have accumulated enough capital and know-how. This philosophy is clearly ref1ected in the numerous performance criteria imposed on foreign investment. Confronted with mixed feelings about private investment'>, especially foreign investments, the formulation of an investment-promotion policy becomes a difficult task. Theoretically speaking, a number of alternative approaches are open to am government in this respect. 8 One government may prefer a policy approach, offering non-discriminatory treatment to all investors irrespective of nationalitY and the activities they are involved in. Another govemmen t may prefer a negotiation approach under which investment projects are negotiated on a case-by-case basis, taking into account all the benefits and costs arising from the project under consideration. In between there is a third approach by which some basic rules are applied to all investments but with sufficient flexibility to allow for differential treatment to special projects. The ASEAN countries can be grouped into the "middle-Df-the-roaders" as t1r

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as institutional and legal infrastructures of investment are concerned. v\'hile basic laws governing private investment in general and foreign investment in particular are restrictive in many ways, they leave a fairly high degree of discretionary power to the government in individual cases. Indonesia's recent experiences in economic deregulation demonstrate clearly the strong position of the government to issue new policies on the basis of pragmatism even if (hey deviate from existing investment laws. For the same reason, the regulatory power of the Board of Investment has also been curtailed a great deal without any amendment to the investment laws. Before we turn to the strong and weak points of pragmatism in the context of the global investment environment outlined earlier, the policy variables that are most fi·equently used by governments in ASEAN while trying to influence the im·estment decisions of the private sector need to be discussed first. Entry regulation is one of them. Some governments produce an "Investment Priority List" consisting usuallv of a "positive list", of industries that are open to new entrant~ and a "negative list", of industries that are closed to new investment~. The level of entry barrier can be fixed on the basis of sectoral priority, regional priority, strategic consideration, the need to promote certain groups of investors, and the scale of investment involved. A government that pursues an import-substitution policy and believes in the infant industry argument is very likelv to include a priority list among its investment policy variables. On the contrary, a government that adheres to exportoriented development and, therefore, can count on a practically unlimited market, can do away with a priority list. The extent to which a priority list has worked to allocate investment to desired areas is difficult to judge. In some instances it certainly has worked effectively. This was clearly the case in Indonesia's banking, which was closed to new entrants when the economy was perceived to suffer from "underbanking". When entry was reopened in October 1988, new banks, including joint-venture banks, and new offices of existing banks literally mushroomed. On the other hand, there are areas where the mechanism of entry restriction through the priority list appears to be redundant. Even without entry regulation, the number of private investors in certain industries such as petrochemicals is not likely to be big. The governments in ASEAN have tended to de-emphasize entry regulation as an investment policy variable. With the strong shift of development policies towards export orientation, the relevance of entry barrier as an investment policy instrument seems to have been lost. What is needed for the time being is, indeed, the abolition rather than the tightening of entry barrier because of the toughening competition for foreign investment. The international "investment market" is basically a sellers' market and is likely to be increasingly so in the years to come. Equity regulation is among the most preferred ways in which governments all over the world seek to influence the investment decisions of the private sector. With the stated intent of facilitating the transfer of enterpreneurial capabilities to local businessmen, the "New Form oflnvestment", that is, a form of establishment in which the foreign partner does not have the m of large-scale R&D in product development, and the ease v~ith which capital can mon' across national borders, which in turn are greatly losing relevance v~th world-wide deregulation. At the same time, the competition for investment increases significantly. Governments are increasingly taking steps to lure investors to their respective territories or dissuade their own investors from going overseas. \\lllTe this competition will eventually lead to only time can tell, but what is to be underlined here is its implications on investment legislation, which has to simultaneously provide a minimum level of security and a sufficient degree of flexibility. Part of the process of the investment decision increasingly imulves the government of the host country negotiating with a potential investor. Countries will continue to have to actively seek out investors; they have to promote themseln's and make it attractive for desired investors to invest in their countries. A~ for the rest of the world, the ASEAN countries are no exception in this regard. Inadequacies in institutional and legal infrastructures in ASEAN include uncertainties arising from pragmatic regulations on investment entry, the duration of investment permit, local equity, the hiring of expatriates, and local content, which have been discussed earlier. Furthermore, the investment legislation in ASEAN has often been criticized for its incompleteness: commercial laws are perceived to be outmoded; legislation on the protection of intellectual properties, which is considered an important variable of investment decisions in a grm\ing number of industries, is either incomplete in the sense that only certain tvpes of intellectual properties are covered, or inadequate in the sense that it provides onlv comparatively substandard protection. Above all, complaints are frequentlv expressed about the poor performance of most ASEAN countries in law enforcement. Investors often accuse the ASEAN countries of tolerating the breach of contract without properly punishing offenders. Investors are unlikelv to ignore these unpleasant sides of investment legislation in exchange for incentives, heme\ er generous they may be. Im·estment legislation in ASEAN includes the provision for the setting up of a Board of Investment as the centre-piece of institutions dealing with priYate investment. Its primary role is to serve investors as a "one-stop service". Policv is usually designed by an inter-ministerial body. It is also the Board of Investment that is primarily responsible for investment promotion both within and ouhidt> the respective ASE.At"J countries. ASEAN economic co-operation has also had some beneficial spin-ofls on investment promotion. A number of investment conferences have been held in ASE.At"J or in the countries of its dialogue partners to brief them on investment opportunities in ASE.Al\. Dialogue with the United States, for example, has led to the establishment of the Private Investment and Trade Organization (PITO), which is expected to improve the effectiveness of consultations between ASEAN and the United States on issues related to investment and trade. Thanks to such external

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dialogues, in which participants are confined to governments, there have been a number of institutionalized meetings between the private sector in the ASEAN countries and their counterparts from the United States, Japan, and the other dialogue partners. The ASEAN-U.S. Business Council, the ASEAN Chamber of Commerce and Industry (CCI), and the Pacific Basin Economic Council, as well as the tripartite Pacific Economic C(H)peration Conference (PECC) are examples ofthe many regional institutions that the ASEAN countries can make use of while trving to get a larger share of private investment from all sources. The ASEAN Industrial Joint Ventures (AijVs) constitute another important institution which is expected to strengthen investment relations not only among private firms of the ASEAN countries, but also between them as a group and foreign imestors. Following the Manila Summit, foreign equity in an AIJV is permitted to be as high as 60 per cent. Products of an AIJV are to be accorded a margin of (tariff) preferences of 90 per cent, with the objective of promoting intra-industry trade among the ASEAN countries. Ideas have also been floated on the co-ordination of investment policy among the ASEAN countries with a view to improving their bargaining position vis-a-vis other host countries as well as vis-a-vis private investors from within and outside the region. Regional co-ordination of investment policy does not enjoy a very good reputation. The Common Investment Code of the Andean Pact is perhaps the most comprehensive code that has ever been negotiated in the context of regionalism. This code, however, is basically nothing more than a set of standardized restrictions on foreign investment. 10 However, the disappointing experiences of the Andean Pact should not be interpreted as saying that regional co-operation in investment legislation is necessarily bad. In the case of ASEAN, agreement is needed to prevent incentive wars and also to avoid unnecessarily duplicating investment as well as to improve the effectiveness of investment promotion through the pooling of limited resources. Such an agreement can take the form of an umbrella agreement in which only certain broad principles are laid down, with the details being taken care of in the individual agreements that each ASEAN country may sign with other countries or even with individual private investors. NOTES 1. 2 3. 4.

5. 6.

i. S. 9. 10.

For a concise analysis of recent policy initiatives, see Djisman (19S8). Cvcles in economic regulation are discussed in Glismann, Rodemer, and Wolter (1984). Empirical evidences are given in Vaitsos (1974). The origin and nature of global competition is extensively discussed in Porter (1986). This shift to alliance between two or more competitors is of relevance to technolog-v-based industries particularlv. though not exclusively. See the "Over\iew'' in Ohmae (1989). The book by Contractor and Lorange (1988) is particularly recommendable in this connection. Equally extensive is the discussion in a number of articles wTitten in a special issue of the Columbia .Journal o.JWorld Business 22, no. 2 (1987). The arguments can be found in Markides and Berg (1988). On the various alternatives see Doz (1986). See also En carnation and Wells . .Jr. (1985). The argument was put forward bv Encarnation and Vachani (1985). The Code was thoroughly discussed in Moxon ( 1977).

Promotion of Private Investmrnt: Institutional and Legallnfrastrurtures

12:)

REFEREKCES Bergsten, C. Frefl. "Corning Investment Wars?" Foreign Afj{Iirs, October 1974, pp. 13:)-:)2. Contractor, FarokJ. and Peter Lorange, eels. Cooperative Strategies in international Businrss. Lexington: Lexington Books, 1988. Crone, Donald. "Emerging Trends in the Control of Foreign Investments in ASEAJ\". A SEAS Su'"'J" (Uni\-ersity of California), no. 4 (1981). Djisman S. Simandjuntak. "Sun·ey of Recent Economic Developments". Bul!Ptin ofindonesian Economi1 Studies (Australian National University), no. 1 (1988). DoL. Yves L. "Government Policies and Global Industries". In Porter ( 1986). Encarnation, Dennis]. "Cross-Investment: A Second Front of Economic Rivaln·". In Amnim vrnus Japan, edited by Thomas McCraw, pp. 117-49. Boston: Han·ard Business School Press, 1986. Encarnation, Dennis J. and Louis T. Wells, Jr. "Sovereignty en Garde: :--Jegotiating with Foreign Investors". International Organization, Winter 1985, pp. 47-78. Encarnation, Dennis]. and Sushi! Vachani. "Foreign Ownership: V\'hen Hosts Change the Rules". Harvard Business Rruiew, September-October 1985, pp. 152-60. Franko, Lawrence G. "Kew Forms of Investment in Developing Countries by U.S. Companies: A Five-Industry Comparison". Colurnbiafoumal of World Businrss 22, no. 2 (1987): 39-56. Glismann, Hans H., H. Rodemer, and F. Wolter. "Long Waves in Economic Development: Causes and Empirical Evidence". In I~ong ~iwes in the Warld Eronomy, edited by Christopher Freeman, pp. 135-63. London: Frances Pinter, 1984. Hirnawan, Charles. The Fareignlnvestment Process in Indonesia: The Role ofLaw in the Economic Devrlopmrnt of a Third World Country. Singapore: Gunung Agung, 1980. International :'vlonetary Fund. Balance ofPayments Statistics Yearbook 1989. _ _ _ . international Finan rial Statistics. Various years. Kriger, .\1ark P. and Patrick] J. Rich. "Strategic Governance: Wlw and How MNCs Are Csing Boards of Directors in Foreign Subsidiaries". Columlna Journal nJWarld Business 22, no. 4 ( 1987): 39--Hi. Markides, Constantinos C. and Norman Berg. "Manub.cturing Offshore Is Bad Business". Hmwml Business Rroiew, September-October 1988, pp. 113-20 . .\loxon, Richard W. "HarmoniLation of Foreign Investment Laws among Developing Countries: .-\.t1 Interpretation of the Andean Group Experiences".Joumal ofCmnmon 1Vlarket Studies 16 ( 1977): :!252. Ohrnae, Kenichi. "The Global Logic of Strategic Alliances".Hammd Business Rrview. March-April1989, pp. 143-54. Porter, Michael E. "Competition in Global Industries: A Conceptual Framework". 1n Competition in Global Industries, edited by .\lichael E. Porter, pp. 15-60. Boston: Harvard Business School Press, 1986. Vaitsos, Constantine. intercountry Inrome Distriln1tion and TransnatiunalLntr-rpri.IP.\. Oxf(>rd: Clarendon Press, 197 4.

8

Venture Capital and Investment Promotion in ASEAN M. Louise Curley

Venture capital, in the broadest sense, is capital that is willing to take high risks in new or expanding, but unproven, businesses in return tor the expectation of high profits. While all capital invested is in a sense ventured, only that part ventured at high risk is considered venture capital. Venture capital is only a small part of total capital raised but its size belies its importance. (In the United States in 1987 a peak ofUS$4.2 billion in venture capital was raised, compared with net new investment in plant and equipment ofUS$77.7 billion.) Venture capital finances Schumpeter's (Schumpeter 1939) "entrepreneurs", the individuals who make the innovations that, in his schema, generate economic evolution. Innovation in the Schumpeterian sense is the introduction of a new production function that results in an increase in the productivity of the factors of production. Innovation, by increasing the capital stock and its productivity, is the catalyst that produces dynamism in the economic process. The availability ofventure capital facilitates the adoption of the innovative new technologies and processes that more cautious capitalists are reluctant to finance. Before V\'orld V\'ar II, venture capital was provided on an ad hor basis by banks, wealthy individuals, and corporations. Today, however, the raising of venture capital and the financing of entrepreneurial activity has become a highly institutionalized operation.

Venture Capital Today The institutionalization of the venture-capital process began in the United States with the formation of the Boston company, American Research and Development Corporation in 1946. This company pioneered the private venture company concept as it is known today. The process was further encouraged by the passage of the Small Business Investment Act of 1958 that provided for the creation of small business investment companies (SBICs). These companies provided a vehicle designed for small business financing, with tax advantages and potential leverage through government lending. At the same time, direct corporate venture-capital projects began to run into difficulties as many large corporations were unable to integrate the risky and speculative nature of venture investing into their more traditional corporate culture. Corporations found it useful to set up separate

l'rnturr Capital and lnvrslmtnt Promotion in ASEAN

127

venture-capital funds of their own. More recently, the private venture-capital firms have designed "dedicated" funds especially for corporations. These funds allow corporate investors to take an active role in the development and management of the investee firm in contrast to the typical fund where the limited partner is passive. The independent private venture-capital company is, today, the dominant force in the industry. At the end of 1988, independent private venture-capital firms in the United States accounted for 80 per cent of the US$31 billion pool of venture capital compared with 13 per cent for corporations and 7 per cent for SBICs ("Special Report: Venture Industry", March 1989, p. 9). The independent private venture-capital firm in the United States raises capital bv forming limited partnerships or mutual funds that are sold to wealthy indi\iduals, corporation, and institutional investors, such as pension and endowment funds and insurance companies. These limited partnerships or mutual funds usually have a specified life span of ten to twelve years, the time generallv needed to see a group of project through to the point where it can operate without special help. During tl1is period the limited partners or investors in the mutual funds may receive income, if any. The bulk of their return, assuming a successful venture, however, is received in the form of capital gains when the investee companies go public or are sold to another investor. Investments in venture-capital partnerships or funds are highly illiquid. In general, there is no organized market for trading shares in the partnerships or funds. In cases where closed-end mutual funds are the vehicle, these funds, if publicly traded, sell at a substantial discount. The venture-capital firm encourages entrepreneurs to submit potential investments, the flow of which is known in the industry as a "deal flow", scrutinizes the projects, and, once one is adopted, generally keeps close supervision over its development, providing marketing, managerial, and financial assistance. \\'hen, and if, the venture reaches the stage where it can operate on its own, the venturecapital firm assists in its public launching or sale to another investor. The typical venture-capital firm generally employs a number of professionals to perform these services. For its role in finding investment opportunities and managing them, the venture-capital firm charges a fee, usually a stated percentage of the capital raised. Venture-capital firms not only invest in start-up businesses but also, by what is called "mezzanine" financing, in firms beyond the start-up stage that are experiencing financial difficulties. The term "mezzanine" financing is also used to describe investments in firms, new or established, that have undervalued assets. In the former case, "mezzanine" financing can be regarded as capital to finance innovations, but in the latter case, it is more difficult to see the connection. The institutionalization of venture capital has increased the amount of capital available by tapping previously untapped sources. Since most venture-capital funds invest in several ventures over the life of the fund, the risk is less than that in a single venture. Moreover, the limited partnership structure limits the liabilitv of the passive investors. The reductions in risk, together with relaxed pension trust fund investment rules in the United States in 1979 that permitted such funds to invest in venture-capital projects, greatly increased the capital pool. In 1978 capital commitments to independent private firms amounted to US$216 million. By 1987

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they had risen to US$4,184 million. The subsequent decline in 1988 to US$2,810 million was due, in part at least, to the 1987 market crash ("Special Report: Venture Funds", February 1989, p. 13). At the end of 1988, there were 658 venture-capital firms of all types in the United States. Table 8.1 shows the number of firms and the total number of dollars managed according to size of firm. TABLE 8.1 U.S. Venture Capital Firms, 1988 Capital under Management

Size of Firm (million US$)

No. of Firms

Billion US$

Percentage

L1nder 10 10-24 25-49 50-74 75-99 100-199 More than 200

213 146 121 61 28 57 32

0.8 2.2 4.1 3.5 2.3 7.5 10.6

2.5 7.2 13.2 11.3 7.6 24.1 34.1

658

31.0

100.0

Total -·

----------

Sm·Rn: "Special Report: Venture Industry" (March 1989, p. 13). A~ can be seen in the table, large firms dominate the industry. More than 58 per cent of the capital was managed by 13.5 per cent of the firms and 34 per cent was managed by only thirty-two firms or 5 per cent of the total. The institutionalized concept of venture capital has spread far beyond the United States. There are Yenture-capital firms today in most of the industrialized countries and in many of the newly industrializing countries (NICs) of the Far East. It is our purpose in this chapter to examine the role of this institutionalized form of \"enture capital in promoting investment among the members of the A~sociation of Southeast Asian Nations (A.SEAN) and in encouraging stronger economic ties between these countries and the United States. Before doing so, we might find it useful to review briefly some of the characteristics of the member nations and the status of their relationships with the United States.

ASEAN

ASEAN comprises Brunei, Indonesia, Malaysia, the Philippines, Singapore, and Thailand. The group has a total gross domestic product (GDP) of over US$200 billion and a population of over 300 million. The area is rich in natural resources and the indiYidual countries possess educated and hard-working populations. It is, howe\"er, an area of v.ide diversity. Of the group, only Singapore has achieYed the status of being a NIC with a per capita income of almost US$8,000. Much of the rest of the area is only beginning to be industrialized, as can be seen in Table 8.2,

Venturr Capital and Investmml Promotion in ASEAX

TABLE 8.2 Distribution of GDP /GNP, 1985 (In percentages) A..SEAN Member

Agriculture

Mining

Manufacturing

Trans. & Commun.

Others

--------

-------

Brunei Indonesia Malavsia Philippines Singapore Thailand

Construction

l 24 21 26 1 17

54 16 10 2 0 3

10 14 20 25 24 20

4 5 5 4 11 5

0 7 6 6 14 9

30 35 38 36 50 46 -----

SOL'RCF: The World in Figures (1987, pp. 165, 172, 188, 194, 198, 203).

which shows the distribution ofGDP/GNP (gross national product) by industrial origin. Brunei is almost entirely dependent on its rich oil deposits. Singapore has the most developed economy. Thailand, the Philippines, and Indonesia are still in the developing stages of industrialization. These countries together with Malaysia have large agricultural sectors. Brunei, Singapore and, to a lesser extent, Malaysia, have small populations and thus limited domestic markets in comparison with Indonesia, the Philippines, and Thailand. The reliance on exports is illustrated in Table 8.3, which shows exports as a percentage ofGDP /GNP. TABLE 8.3 Exports as a Percentage of GDP /GNP Brunei Indonesia Malaysia Philippines Singapore Thailand

69.1 24.6 56.0 16.5 143.9 24.7

----------

Srll'RCE: Data for Brunei were taken from Government of Bmnei Darussalam (1988, pp. 112-14); those for the other countries from International Monetary Fund (1989, pp. 288,290,350,428, 466,514,516).

In addition to the economic differences among the ASEAN members, there are ethnic, cultural, and religious differences that affect the degree to which the different countries interact with venture capitalists and the nature of that interaction.

1'>0

ASEAN-U.S. Relationships The United States has supported ASEAN and has generally cordial relationships \\·ith all of its members. Its strongest political ties are with the Philippines, though these ties are currently being strained by discussions over the U.S. naval bases in the area. In the sphere of economic relations, friction in economic matters has surfaced with the threat of protectionist measures on the part of the United States, and lack of protection of U.S. intellectual property rights, such as copyrights and patent protection of U.S. pharmaceutical products on the part of some of the member nations. ASEA.t'\1 -L' .S. trade was about US$34 billion in 1988, making ASEAN the seventh most important trading partner of the United States. Table 8.4 shows 1988 U.S. exports to and imports from the A_"EAN member countries excluding Brunei, for which data are not available. TABLE8.4 LTS. Trade with ASEAN, 1988 (In million US$) Exports

Balance

Imports ------·

Indonesia Malaysia Philippines Singapore Thailand Total

1,056.0 2,139.6 1,880.4 5,769.6 1,964.4

3,188.4 3, 711.6 2,682.0 7,995.6 3,218.4

-2,132.4 -1,572.0 -801.6 -2,226.0 -1,254.0

12,810.0

20,796.0

-7,986.0

SoL·RcE: Organi7ation for Economic Co-operation and Development (1989, pp. 50-51).

U.S. direct investment in ASEAN amounted to about US$10 billion at the end of 1988. The distribution is shown in Table 8.5. While still the largest foreign investor in these countries, Japan has begun to overtake the United States in annual new direct investments. TABLE 8.5 U.S. Direct Investment in ASEAN, 1988 (In milhon US$) Indonesia Malaysia Philippines Singapore Thailand

3,006 1,363 1,305 3,005 1,126

Total

9,805

SoLTRCE: Scholl (1989, p. 46).

Frnturr Capital and Irzvrstment Promotion in ASEAl'v'

131

Venture Capital in ASEAN

Venture-capital firms have been active in Asia for more than a decade, but the pace of activity accelerated in the 1980s. As evidence of the widespread interest in venture capital in Asia a new journal, Asian Venture CapitalJournal, was launched in January 1988. In an editorial in its first issue, the editors noted that the venturecapital industry in Asia had reached the take-Dff stage ("Inaugural Editorial", 1988, p. 2). Shortly following the birth of the Journal, the Asian Development Bank (ABD) sponsored in April 1988 a symposium on venture capital in Bangkok, Thailand. Many of the world's leading venture-capital firms as well as representatives from Asian governments and international agencies attended, prompting the Asian Venture Capital Journal to comment that venture capital has come of age in Asia ('Venture Capital Comes of Age in Asia", 1988, p. 3). vVhile this may be so, it is still, except for Singapore, in it~ early childhood in ASEAN. The Government of Singapore, along with those of the other NICs, South Korea, Taiwan, and Hong Kong, have actively encouraged venture-capital firms as a means of transferring technology to their countries. As a member of ASEAN, Singapore's experience with venture capital is particularly relevant and deserves a look as a possible model for the other ASEAN members. The Singapore Government has provided a number of incentives for the venture capitalist: pioneer status to organize funds, tax holidays of up to ten years, and tax write-offs if venture-capital investments fail. In 1987 the government set up an unlisted securities market called the Stock Exchange of Singapore Dealing and Automated Quotation System (SESDAQ). The criteria for listing are much less stringent than those for listing on the Exchange and are designed to encourage listing by small companies such as investee companies of a venture-capital fund. The Economic Development Board (EDB) of Singapore plays an important role in stimulating venture-capital activity. An EDB Venture Capital Group has been set up to participate in venture-capital funds, both domestic and foreign, and to provide capital to entrepreneurs through its own S$100 million fund formed in 1985. The EDB encourages the inclusion of "buy-back" provisions that allow local management to regain full control over an investment once the risk level has been reduced. "Buy-back" provisions provide an alternative to initial public offerings for the venture capitalist to realize his returns. The EDB Venture Capital Group also sponsors the Singapore Venture Capital Club, where venture capitalists, prospective investee entrepreneurs, and other interested parties can meet and deal. Another distinctive feature of the background in Singapore is the Singapore Science Park, situated next to the Singapore National University. The Science Park is equipped to conduct research and development (R&D) activities from the idea stage to commercial development. Research funding from the Singapore Government covering 30 to 50 per cent of R&D expenses in the Science Park can be made available to companies. These incentives have encouraged venture capitalists to begin operations at the Science Park and then move them into the mainstream of Singapore's industrial activity.

132

M. Lauise Curley

These incentives, together with Singapore's relatively well-developed economy, its highly educated population, and a maturing stock market, have fostered the growth of venture capital in the country. The main U.S. involvement in venture-capital projects in Singapore has been undertaken by TA Associates/ Advent International. South East Asia Venture Investment (SEAVI), which began its activities in 1984, is a member of the Advent International network of venture firms, specializing in venture-capital projects located in ASEAN or with linkages to the other ASEAN members. SEAVI focuses on technology-transfer projects, that is, joint ventures with American or European medium-sized companies that can be encouraged to expand their manufacturing or marketing activities to the Far East, especially Singapore. At the end of May 1989, SEAVI had five funds with a total of US$71.6 million. Of this total, US$36.1 million had been invested. The size of investments ranges from a low of US$220,000 to a high of US$2 million. SEAVI invests in start-ups, earlystage, and later-stage pr~jects. The typical investment period ranges from three to seven years. Investors in SEAVI include institutions from the United States, Europe, the Middle East, Singapore, and Malaysia. Investments have been made in Singapore, the United States, Malaysia, the United Kingdom, and France. Some of SEAVI's Singaporean investments are shown in Table 8.6. TABLE 8.6 SEAVI Investments in Singapore ---···

-------

Company

Product/Service

Amtek Engineering Ltd. Dynamar Computer Systems Electro Magnetic (Singapore) Pte. Ltd. Esco Scientific Products Medi-Rad Associates Pte. Ltd. PBIX Consultancy Pte. Ltd. Research Pacific Pte. Ltd. Teledata (Singapore) Pte. Ltd. Transnational Express Courier Services Pte. Ltd. Unitrode Electronics (Singapore) Pte. Ltd. Venture Manufacturing (Singapore) Pte. Ltd.

Metal-stamped precision parts Electronic components Manufacturer of magnetic videotapes Microcontamination control Radiologic clinic Videotext service Optic and video technology PABX systems distributor Cheques courier service Integrated circuit packaging Offshore manufacturing and technology transfer services

·-----

-----

SmR (Februarv 1989). "Special Report: Venture Industry Growth Brings Capital Pool to $31 Billion". Venture Capitalfou mul 29, no. 3 (March 1989). The \Vorld in Figures. Norfolk, Great Britain: Economist Publications, 1987. "Trans tech Venture Management Pte Ltd". Asian Fenture Capital joumal2, no. 4 (Juh 1989). "Venture Capital Comes of Age in Asia". Asian Venture Capital]!Y11mal1, no. 3 (May 1988).

9

Franchising in the ASEAN Nations Robert T. Justis and Ben Kedia

Franchising is a very unique method of doing business that is rapidly spreading throughout the world. Franchising is becoming the fastest-growing method of doing business in the industrialized and developing nations of the world. Franchising has had a dynamic and positive impact on the retail and service sectors of the Canadian, Japanese, and U.S. economies. Governments and business associations have accepted a pro-active role in helping develop franchising in their own countries. Franchising provides a higher economic use of resources and reduces the number of business failures with an accompanying reduction in investment and job losses. Franchising explores and develops the local entrepreneurial spirit while providing a training ground for business managers and new entry-level jobs. Domestic franchisors may easily learn from the foreign systems and develop their own market sectors where franchise systems best serve the economy. Franchising may be defined as a business opportunity by which the owner (franchisor) of a service or bu~iness grants exclusive rights to another individual (franchisee) for the local sale or distribution of a product or service, and in return receives a payment or royalty in conformance to quality standards (Justis and judd 1989, p. 6). The franchisor simply grants another individual the privilege or right to operate a business in a prescribed manner. Generally, this agreement is referred to as a franchise contract and is for a limited period of time and for a specific location. The U.S. Department of Commerce provides a broader definition of franchising: Franchising is a method of doing business by which a franchisee is granted the right to engage in offering, selling, or distributing goods or sen~ces under a marketing format which is designed by the franchisor. The franchisor permits the franchisee to use the franchisor's trademark, name, and advertising. (Kostecka 1989, p. 2)

Franchising can be a very appealing method of doing business from either the franchisor's or franchisee's perspective. Franchising allows the franchisor to expand a proven concept and method of operation from a single unit to a larger operation with multiple locations and a variety of product or service offerings. The franchisee has a great opportunity for growth by utilizing proven methods of operations, high-

141

Fmnchising in the ASEAN 1\'ations

impact advertising, recognized trade marks or brand names, proven promotional methods, and ongoing managerial and technical assistance. These advantages given to a franchisee are generally not found in independent small businesses or other businesses selling a similar product or service. Franchising now embraces many different types of businesses, relationships, and marketing techniques and is involved with myriad companies, products, and services. Companies are expanding throughout the world by using the franchising method. This includes automobiles, trucks, restaurants, hotels and motels, convenience food stores, soft drink bottlers, domestic maid services, apparel retailing, automotive products and services, real estate, insurance services, and a variety of business aids and services (see Figure 9.1).

History During the 1850s, the Singer Sewing Machine Company in the United States experienced difficulty in selling its new product, the sewing machine. This was a revolutionary new concept and people did not know how to operate such a machine. The Singer Company decided to hire agents working on a commission to demonstrate, sell, and repair the Singer line of sewing machines. For almost twenty years, Singer used this "franchising" method of doing business. However, once the sewing machine caught on and people understood how to use it, Singer changed its marketing approach and began selling exclusively through companYowned offices during the late 1860s. General Motors in 1898, and Rexall Drugs in 1902, soon followed suit and began distributing their products through a franchising system. The major automobile manufacturers did not have sufficient capital to establish multiple retail outlets in a short period of time, so they chose to use franchise dealers instead. Soon afterwards, other companies started to utilize the franchising method. These companies included petroleum, soft drink bottling, automotive parts, and a varietv of retail merchandising stores. In 1955, Ray Kroc started the great boom in franchising by franchising the first McDonald's hamburger restaurant. Ray Kroc stressed "quality, service, and cleanliness and value". Those four qualities have been at the heart of mam successful franchising operations since that time. Harlan Sanders carved his niche in the food industry in the 1950s with the founding of Kentucky Fried Chicken. In 1959 the International House of Pancakes opened its doors and, since that time, has sold millions of breakfasts. Today franchising has grown to be one of the most popular methods of doing business in the United States and throughout the world. Over one-third of all retail sales in the United States are attributed to franchised businesses. ApproximatelY 20 per cent of the U.S. gross national product (GNP) is the result offranchised businesses. Many firms have grown to rival the giants of industry through their franchising operations, including McDonald's, Sheraton Hotels, Hertz Rent-A-Car, Kentucky Fried Chicken, and Dairy Queen International.

FIGURE9.1 International Franchising, 1986

t,'