Liberalising foreign direct investment policies in the APEC region 9781315193618, 1315193612, 9781351758604, 1351758608, 9781351758611, 1351758616

Table of contents :
The Investment Liberalisation Process in APEC --
The Current State of Foreign Investment Policies in the APEC Region --
The Constraints to Further Liberalisation --
The Neglected Issue of Investment Incentives --
Policies for a Liberalised Investment Environment.

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LIBERALISING FOREIGN DIRECT INVESTMENT POLICIES IN THE APEC REGION

This book is dedicated to my family.

Liberalising Foreign Direct Investment Policies in the APEC Region

BERNIE BISHOP School of International Business Griffith University

ROUTLEDGE

Routledge Taylor & Francis Gruop

LONDON AND NEW YORK

First published 2001 by Ashgate Publishing Reissued 2018 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN 711 ThirdAvenue, New York, NY 10017, USA Routledge is an imprint of the Taylor & Francis Group, an informa business

Copyright © Bernie Bishop 2001 All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Publisher's Note The publisher has gone to great lengths to ensure the quality of this reprint but points out that some imperfections in the original copies may be apparent. Disclaimer The publisher has made every effort to trace copyright holders and welcomes correspondence from those they have been unable to contact. A Library of Congress record exists under LC control number: 200108877 5 ISBN 13: 978-1-138-72232-3 (hbk) ISBN 13: 978-1-315-19361-8 (ebk)

Contents List o f Figures and Tables Acknowledgements List o f Abbreviations

VI vii VM

Introduction

1

1

The Investment Liberalisation Process in APEC

9

2

The Current State of Foreign Investment Policies in the APEC Region

39

3

The Constraints to Further Libéralisation

79

4

The Neglected Issue of Investment Incentives

120

5

Policies for a Liberalised Investment Environment

145

Conclusion

172

References Index

182 197

v

List of Figures and Tables Figure 1.1: Total Foreign Investment Inflows for APEC Economies

6

Figure 1.2: Transnationality Index

7

Figure 1.1: APEC’s Investment Related Bodies

Table 5.1:

Corporations in East and Southeast Asia with 20 per cent Family Control (unit: %)

vi

10

158

Acknowledgements I would like to acknowledge the assistance given to me by the staff of the APEC Secretariat in providing hard copies of many public APEC documents and in discussions with me about my research. I would also like to acknowledge the financial support provided by the School of International Business, Griffith University for this research. Finally I would like to thank Maureen Todhunter and Robyn White for their improvements to this book and my publishers for their patience.

Note All dollar figures in this book represent $US unless stated otherwise.

Vll

List of Abbreviations APEC Business Advisory Council ASEAN Free Trade Area Asia Pacific Economic Cooperation Association of Southeast Asian Nations Indonesian Investment Coordinating Board Indonesian Regional Investment Co-ordinating Board chief executive officer Closer Economic Relations - Australia and New Zealand Committee on Foreign Investment of the United States Copper Commission of Chile National Commission on Foreign Investment and Technology Decree Law DL East Asian Executive Reports EAER export oriented industry EOI Eminent Persons’ Group EPG European Union EU foreign direct investment FDI Far Eastern Economic Review FEER FIA foreign investment approved Foreign Investment Review Board FIRB General Agreement on Trade in Services GATS General Agreement on Tariffs and Trade GATT gross domestic product GDP heavy and chemical industry HCI International Convention for the Settlement of Investment ICSID Disputes Investment Experts Group IEG International Monetary Fund IMF Korea Investment Services Centre KISC merger and acquisition M&A MERCOSUR Southern Common Market Malaysian Industrial Development Authority MIDA multinational corporation MNC ABAC AFTA APEC ASEAN BKPM BKPMD CEO CER CFIUS COCHILCO CONITE

vm

List o f Abbreviations

MOFTEC NAFTA NBIP NCFI NEP NIE OECD OIC PBC PECC PEZA R&D RHQ SEZ TRIM UMNO UNCTAD UNCTC WTO

ix

Ministry of Foreign Trade and Economic Relations North American Free Trade Area non-binding investment principles National Commission of Foreign Investment New Economic Policy newly industrialised economy Organisation for Economic Cooperation and Development Overseas Investment Commission Pacific Business Council Pacific Economic Cooperation Council Philippine Economic Zone Authority research and development regional headquarters special economic zone Trade Related Investment Measures United Malay National Organisation United Nations Conference on Trade and Development United Nations Centre on Transnational Corporations World Trade Organisation

Taylor & Francis Taylor & Francis Group http://taylorandfrancis.com

Introduction The three pillars of Asia Pacific Economic Cooperation (APEC) are trade and investment liberalisation, trade and investment facilitation and economic cooperation. These were outlined by the APEC eminent persons group and accepted by Leaders of member economies at their second meeting in Bogor in 1994. The target for trade and investment liberalisation established at the Bogor meeting is to eliminate all barriers to intraregional trade and investment by 2010 for developed countries and by 2020 for less developed countries. This is to be achieved through principles of open regionalism with negotiated reductions in barriers applying not only to member economies but also to the rest of the world. To accompany the liberalisation process, it has also been agreed that it is necessary to work on measures that complement liberalisation by facilitating trade and investment. These measures include harmonising rules of origin, customs procedures, standards, intellectual property rights and movement of business people. In view of the differing levels of economic development in the region, it was also recognised as necessary to encourage economic cooperation so that less developed countries have both the physical and institutional structure to support a liberalised trade and investment environment. Critics of the APEC process often argue that it is moving too slowly and that the Bogor targets are unlikely to be reached. In the arena of trade and investment liberalisation some have suggested that the non-binding consensual nature of APEC provides member countries with ample opportunity to renege on their agreements. Peer pressure is seen to be less effective than the rule based approach to regional integration as adopted in the European Union (EU) for example. Criticisms along these lines come from both inside and outside the APEC process. Some member countries and some business groups within them prefer faster progress in liberalisation and facilitation measures. Others emphasise the need for more economic cooperation before liberalisation can be effective. This book is a response to criticisms that APEC liberalisation is not moving fast enough. The book concerns foreign direct investment (FDI) in the APEC region and focuses specifically on liberalisation of investment regimes in member countries. It advances the argument that progress is 1

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Liberalising Foreign Direct Investment Policies in the APEC Region

being made toward a liberalised investment environment but significant economic and political difficulties prevent more rapid progress. The view here is that a liberalised investment environment involves the removal not only of barriers to entry for foreign investment but also of investment incentives. It accepts the position that to achieve a truly level playing field for investment, abolishing barriers to investment without also removing investment incentives may result in distortions in investment patterns almost as great as if the barriers had remained in place. I also hold that along with the removal of both barriers to entry and incentives, progress has to be made on implementing new policies necessary for a newly liberalised environment. I argue that the standards of corporate governance within countries in the region will play an increasing role in investment decisions. Further, as barriers to investment are removed, it is vital to have in place an adequate competition policy not only to ensure that new measures do not spring up in place of the old but also to ensure that local firms are not unfairly discriminated against by the greater economic might of incoming multinational firms. Thus the arguments in this book concern formal entry barriers and incentives. I recognise two types of barriers to foreign investment - formal and operational. Formal barriers are specific to foreign investors only. Thus, screening requirements, sectoral restrictions and restrictions on the extent of foreign ownership in various industries are formal entry barriers. Operational barriers arise once firms begin operations within a country after they have negotiated the formal entry barriers. Operational barriers include regulatory issues such as those relating to capital movements, employment of expatriate personnel and trade regulations. But these barriers also extend to business practices including the difficulties for foreigners breaking into established business patterns within the host country and intimate relationships between business and government that may give local companies an advantage over foreign investors. I acknowledge that operational barriers present obstacles to a truly liberalised investment environment that are as formidable as formal entry barriers. However operational barriers are often industry specific and to attempt to examine them in any meaningful way requires specific industry research. Further, many operational barriers confront not only foreign investors but also local investors. Thus, I have confined this study of liberalisation of investment to formal entry barriers only.

Introduction

3

Chapter 1 overviews the APEC structure focussing on the parts most relevant for foreign investment liberalisation. It then provides a history of investment liberalisation in APEC from initial inclusion as an agenda item through to formal establishment of the APEC Trade and Investment Committee with a specific subcommittee - the investment experts group (LEG) - devoted to pushing forward the liberalisation agenda. I review the initiatives of this committee and its LEG from inauguration in 1994 to 2000. I then look in detail at the provisions of APEC’s non-binding investment principles agreed to in 1994 at Bogor, especially the principles most relevant for the elimination of formal entry barriers. The principles are broadly based and tend to include measures aimed at removing both formal and operational barriers to investment. Chapter 2 offers an assessment of the state of investment liberalisation in the APEC region in 2000. Reviews of the foreign investment policy of each member economy consider the extent to which formal entry barriers continue to operate, with analysis of the extent of screening mechanisms, sectoral restrictions and limitations on foreign equity. I discuss sectoral restrictions under the broad headings of agriculture and land, natural resources, manufacturing, general service sectors and sensitive service sectors, revealing agriculture, natural resource industries and sensitive service sectors as the most heavily restricted. In examining the current state of liberalisation in each of these areas, I canvass the extent to which the action plans of individual member economies propose measures to further remove restrictions. Chapter 3 discusses the economic and political constraints to further liberalisation in the APEC region. It begins by recognising a gap between economic constraints in developing and transition economies on the one hand and economic constraints in the developed and newly industrialised economies (NIEs) on the other. For the developed and NIEs I argue that the major role of foreign investment is to provide a competitive spur to industry as well as to provide capital, employment and spinoffs through introducing more advanced technology, management and marketing skills. I suggest that it is difficult for policymakers in these countries to argue there are valid economic concerns about investment liberalisation. Much of the work on the validity of economic arguments against investment liberalisation concerns the US experience and in reviewing these arguments I suggest they are largely applicable to the other developed and

4

Liberalising Foreign Direct Investment Policies in the APEC Region

NIEs in the region. However, in the developing and transition economies I argue that there are genuine economic development concerns about rapid liberalisation. A review of empirical research demonstrates that it is far from clear whether rapid liberalisation of investment restrictions will lead necessarily to the establishment of vibrant local industry, even though this is one of the major outcomes that developing countries desire from foreign investment. All countries face political constraints to more rapid liberalisation. We consider examples of these constraints in a number of countries to illustrate the extent of the problem and the magnitude of APEC’s task in achieving liberalisation in the face of pressure for maintaining the status quo. Given that political constraints are the major factors inhibiting faster reform in the developed economies and that they play a significant role in slowing liberalisation in the developing economies, it is surprising there is so little published research analysing these constraints. Other than studies concerning the US, there is very little work on political constraints in specific countries in the APEC region. I review the studies done on the US and recommend further research in this area on other member economies to highlight the potential political difficulties of investment liberalisation. Chapter 4 turns to a relatively neglected aspect of investment liberalisation in the APEC process - the issue of investment incentives. A review of APEC member economies finds that these incentives are extensive and increasing, largely due to competition for various classes of investment, including investment projects that will increase export earnings, contribute to the development of technological capability, assist in developing underdeveloped regions or create jobs. The older economies tend to hide incentives through offering them at the sub-national level, contrasting with the developing economies that tend to offer incentives at the national level. This chapter canvasses arguments against investment incentives. While the previous chapter notes some disagreement among economists concerning the wisdom of removing investment barriers, this chapter notes almost unanimous agreement that it is in the interest of all countries to scale back incentives. The minimal scaling back in the APEC process may therefore seem surprising and the chapter advances several reasons why it is difficult to obtain agreement in this area. Chapter 5 turns to the future with an examination of policy measures appropriate in a more liberalised investment environment. The chapter

Introduction

5

pursues the argument that rather than fiscal incentives, improvements in corporate governance may be more effective in attracting investment in the future, and that as formal entry barriers to foreign investment are removed it will be necessary to have in place a working competition policy that benefits both investors and host economies. The first section of the chapter analyses what is meant by good corporate governance, reviews some criticisms of corporate governance practices in the region and assesses the potential for change. The second section reviews the basics of competition policy and discusses some of the obstacles to its implementation in the region. The conclusion to the book draws together the main findings of each chapter. On this basis I offer a number of suggestions concerning the future of the APEC process including pointers to further research that might be undertaken to support it. This introduction would not be complete without noting the increasing significance of investment in the region as well the reliance of member countries upon this investment for their continued economic growth. In view of this, efforts at liberalisation may be important to ensure continued investment flows and hence continued economic growth in the region. This assessment relies to a considerable extent upon statistics on FDI collected by the United Nations Conference on Trade and Development and reported in its annual world investment report. The most current statistics available are contained in the 1999 World Investment Report. Figure 1.1 shows the total foreign investment inflows to all of the APEC economies for the years 1993-98. In 1993 APEC firmly recognised investment liberalisation as one of its primary objectives. It is clear from Figure 1.1 that investment flows have increased at a significant rate since 1993, with the 1998 amount almost three times that of only five years earlier. However, this increase in foreign investment needs to be considered in the broader context of total flows of foreign investment worldwide. APEC’s share of worldwide flows of foreign investment has remained relatively constant at about 50 per cent over the 1993—98 period (UNCTAD 1999a). Thus while we see a significant increase in investment, APEC’s performance in attracting increased amounts has remained more or less constant in world terms. Of more concern is that if investment inflows into the US are excluded, the UNCTAD statistics show that the share of world investment going to

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Liberalising Foreign Direct Investment Policies in the APEC Region

the APEC region averages about 40 per cent from 1993 to 1997 with a significant decline in 1998 to only 27 per cent. It can therefore be concluded these figures virtually confirm that foreign investment in the APEC region was significantly affected by the Asian crisis. It will be necessary to track more recent figures as they become available to determine if the level of foreign investment is returning to the pre-crisis level. Further concerns are evident when we examine the concentration of foreign investment inflows in the region. The combined inflow to the North American Free Trade Area (NAFTA) economies consistently represents around 50 per cent of all investment inflows to APEC economies. If investment inflows to China and Singapore are added, the figure becomes closer to 80 per cent. Thus five of APEC’s 21 member economies account for nearly 80 per cent of total inward foreign investment into the region.

Source: UNCTAD (1999), World Investment Report 1999, Annex table B.

Figure 1.1: Total Foreign Investment Inflows for APEC Economies The significance of foreign investment in each economy therefore varies considerably across the region. A useful measure of this is United Nations Conference on Trade and Development (UNCTAD) Transnationality Index. The index aims to show the relative importance of foreign investment in individual economies. It is compiled by averaging four different measures of the role of foreign investment in an economy.

Introduction

7

These are: FDI inflows as a percentage of gross fixed capital formation; FDI inward stock as a percentage of gross domestic product (GDP); value added of foreign affiliates as a percentage of GDP; and employment generated by foreign affiliates as a percentage of total employment. UNCTAD points out that because not all of these indicators are available for every economy, estimates are sometimes needed. The transnationality index for APEC member economies is shown in Figure 1.2. This is based on 1996 statistics that were the most recent available to UNCTAD when compiling its 1999 world investment report. Using 1996 figures also avoids the distortions caused in 1997 and 1998 by the Asian economic crisis.

Source: UNCTAD (1999a), World Investment Report 1999, p. 17.

Figure 1.2: Transnationality Index The transnationality index shows that most APEC economies are dependant on foreign investment to at least the 10 per cent level. Singapore, New Zealand and Malaysia are highly dependent on foreign investment. The larger economies of Japan and the US have yet to show significant dependence. However, in the case of the US, it is quite likely that rapid inflows of investment since 1996 have significantly increased its dependence above the 5 per cent shown here. Inflows to Japan are still relatively small; over the 1993-98 period they were less than inflows to one of APEC’s smaller members - New Zealand. This suggests continuing

8

Liberalising Foreign Direct Investment Policies in the APEC Region

difficulties for foreigners in penetrating the Japanese market. As I argue later, the difficulty may be due more to operational restrictions and the overall business environment rather than formal entry barriers. Korea, like Japan, demonstrates a very low dependence on foreign investment. Inflows to Korea have increased considerably during 1999 and 2000 but some time will be needed for its transnationality index to approach the levels of most countries in the region. Massive inflows of foreign investment to China averaging some $40 billion per year have transformed China from an inward looking, closed economy at the end of the 1970s to one that is significantly dependant on foreign investment just two decades later. The Southeast Asian countries show considerable variation in the role of foreign investment in their economies - Thailand and the Philippines still hover at around the 6-7 per cent level while Indonesia shows significant dependence at 15 per cent and as noted, both Malaysia and Singapore have very high dependence ratios. The older industrialised economies of Australia and Canada show a transnationality index of 18 per cent and 14 per cent respectively. It is likely that in Canada’s case this has risen since 1996 given the continuing movement towards integration of the US and Canadian economies since the formation of NAFTA. Of the Latin American countries, Chile shows the highest dependence on foreign investment; Chile opened its economy in the late 1970s while in Mexico this came only in 1989 and in Peru in the early 1990s. The overall conclusion from this brief examination of trends in FDI inflows in the region is that many APEC economies may be falling behind others in the region and beyond in attracting their share of worldwide foreign investment. Since there is evidence that a more liberalised investment environment may lead to increased investment flows, if economies in the region wish to increase their investment levels the issue of liberalisation is important. While significant liberalisation has taken place over the past decade, further progress will be difficult. This is due to a reluctance to remove fiscal incentives as well as economic and political constraints on the removal of formal entry barriers. This book aims to bring these complex issues out into the open. I hope that discussion here will encourage debate on these issues, as part of further progress toward more liberalised foreign investment policy regimes and the benefits that this outcome can bring.

1 The Investment Liberalisation Process in APEC Introduction Cooperation on investment issues within APEC was first raised at the inaugural APEC Meeting in Canberra in 1989. However, for the first four years of its existence APEC concentrated on initiatives that might facilitate investment flows in the region, rather than embarking on a strategy to liberalise investment. In 1993, liberalisation initiatives received a significant boost with recommendations from newer groups within the APEC process including Leaders, the Eminent Persons’ Group (EPG), the Pacific Business Forum and the Committee on Trade and Investment. A specific sub-committee, the IEG, was given primary responsibility for pushing along the liberalisation goals. This structure enabled significant progress, including the development of APEC’s non-binding investment principles (NBIP) and their implementation through action plans developed at both the individual economy level and cooperatively. A newer development has been a menu of options that provides member economies with a list of measures that they might take to liberalise their investment regimes. We can summarise the milestones in the APEC investment liberalisation process as the initial inclusion of liberalisation as an agenda item in the first APEC Meeting in 1989, the boost given to this process by the recommendations of the newer APEC bodies formed in the 1993-94 period and finally the significant steps taken by the BEG from 1994 until the present time. This chapter begins with a brief look at the various agencies that have key roles in investment liberalisation in the APEC process. A brief historical review follows, setting out the beginnings of investment liberalisation as an APEC agenda item. I then discuss the boost that newer groups in APEC have given to the liberalisation agenda. Finally, I canvass in greater detail the specific initiatives taken since 1993: the adoption of the NBIP, the development of individual and collective action plans and

9

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Liberalising Foreign Direct Investment Policies in the APEC Region

the formulation of a menu of options that individual member countries might adopt.

APEC’s Current Organisational Structure Concerning Investment Figure 1.1 shows those parts of the APEC organisational structure most relevant in the investment liberalisation process. Let us look briefly at the role of each of these bodies, in investment liberalisation and in the APEC process generally. APEC Business Advisory Council

Leaders' Meeting

Eminent Persons' Group (until 1995)

Economic Ministers' Meeting

Senior Officials

Committee on Trade and Investment

Investment Experts Group

Figure 1.1: APEC’s Investment Related Bodies

The Investment Liberalisation Process in APEC

11

The most prominent forum in APEC is the Leaders’ Meeting attended by the heads of government of each APEC member economy. The first Leaders’ Meeting was held in Seattle in 1993 at the request of US President Clinton, with meetings being held annually on a rotating basis around member economies. The economy hosting the Leaders’ Meeting also hosts many of the meetings of other APEC related bodies during that year. It has also been practice that the head of the APEC secretariat for that year is a government representative of the host country. The APEC process is currently geared heavily towards producing policy initiatives for Leaders to consider and endorse. Without the focus of the annual Leaders’ Meeting, APEC may be in danger of drifting with the day to day domestic concerns of Economic Ministers and Senior Officials crowding out attention to regional economic matters. Following each Leaders’ Meeting the Leaders issue a joint statement endorsing the policy initiatives that have emerged from the ministerial processes and the various advisory bodies. In terms of investment, the most significant contributions of the Leaders’ Meetings have been to firmly endorse investment liberalisation as one of APEC’s three pillars and to approve the NBIP. Additionally, as investment is one of the items on APEC’s action agenda, the Leaders’ endorsement of the action plan process has ensured that there is a mechanism for following through with the liberalisation ideal. At the outset, Leaders noted that they needed not only the input from their own Economic Ministers supported by Senior Officials but also independent advice. To this end the APEC Leaders recommended establishing the Pacific Business Council (PBC) to report on trade and investment liberalisation matters in 1993. The PBC evolved into the more permanent APEC Business Advisory Council (ABAC) in 1996. Each year ABAC meets three times and delivers an annual report to Leaders. As I note below, ABAC recommendations are often sharper than those emanating from the ministerial process, with less tendency to take into account political realities - particularly concerning the timeframe required for policy change. In this respect Leaders need to balance the advice coming from their Economic Ministers and from ABAC. The EPG was a further independent advisory body to the APEC process, established by Economic Ministers at their Bangkok meeting in 1992. The EPG was mandated to provide a vision for APEC’s future and produced three reports in 1993, 1994 and 1995. The EPG has significantly influenced APEC’s overall direction, with its recommendations

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Liberalising Foreign Direct Investment Policies in the APEC Region

culminating in Leaders adopting trade and investment liberalisation, trade and investment facilitation and economic cooperation as APEC’s three pillars in 1994. The EPG was also the body directed by Leaders to devise a non-binding investment code. The Economic Ministers’ Meeting was the inaugural forum for APEC. It met for the first time in Canberra in 1989 and has held annual meetings since that time. In its early days the Economic Ministers’ Meetings seemed to be grasping for a common direction for APEC and it was probably recognising this that the group wisely decided to bring in outside advice in the form of the EPG. The Economic Ministers’ Meetings dealt in some detail with investment issues in the earlier years but after the formation of the Committee on Trade and Investment in 1993, much of the detail has been left to this committee. A Senior Officials’ group has supported Economic Ministers since 1990. Senior Officials meet three times annually to review the progress of the various APEC Committees including the Committee on Trade and Investment. Given their pivotal role in receiving recommendations from below and providing advice to ministers above, the Senior Officials have significant power in determining the pace and direction of various APEC matters. With the range of issues dealt with in the APEC process continuing to expand, Economic Ministers and Leaders cannot keep abreast of them all and often it is therefore left to Senior Officials to determine priorities. It is difficult to gauge the priority given to investment matters by Senior Officials but as is the case with the meetings of Leaders and Economic Ministers, the wide ranging agenda of Senior Officials’ Meetings may lead to some crowding out of investment issues. Economic Ministers established the Committee on Trade and Investment in their Declaration on Trade and Investment in 1993. This committee consists of trade policy officials from each member economy. It oversees the work of APEC on trade and investment liberalisation and reports annually to Economic Ministers via Senior Officials. One of its 12 subcommittees - the IEG - is specifically mandated to carry forward APEC’s investment liberalisation objectives. Yet while investment is dealt with by this one sub committee specifically, investment issues are clearly also of concern to several other subcommittees, particularly those dealing with services, intellectual property rights, competition policy, deregulation and dispute mediation. Given the range of issues that those parts of the structure above this group need to deal with, the IEG has considerable responsibility in

The Investment Liberalisation Process in APEC

13

devising strategies to bring about investment liberalisation in time to meet the Bogor goals. The work of the subcommittee is supported by a single member of the APEC secretariat who often has responsibility for another subcommittee as well. The achievements of the IEG and other subcommittees depend to a considerable extent on the efforts of the member of the secretariat staff allocated to this role, along with the current Chair of the particular subcommittee. The IEG consists of a representative from each member economy’s investment authority. Its three meetings annually usually immediately precede those of Senior Officials so that recommendations from the IEG can be passed directly to them. Those who argue that APEC is achieving very little in the liberalisation area often overlook the work of the IEG. In its five years of existence, the IEG has made considerable advances including drafting the NBIP, developing a menu of options for implementing the action plan as it relates to investment, publishing a comprehensive investment guide setting out the investment rules of each member economy, holding biennial investment seminars and organising training programs for investment officials. However, perhaps its greatest contribution will in the end be the improved communication between investment officials and investment authorities in the region. Officials learn much through their interaction at the IEG Meetings and it may well be this interaction that contributes most to the actual policy change required to bring about an open investment regime in the region. Here we also need to acknowledge the role of the Pacific Economic Cooperation Council (PECC) in the APEC process. PECC was formed in 1980 and consists of business, government and academic representatives of each Asia Pacific country. PECC also has a range of subcommittees, with one that deals specifically with trade liberalisation. PECC has permanent observer status at all APEC Meetings and through that mechanism is able to provide input to APEC decisions. PECC prepared the first draft of an investment code in 1993 and it was this code that formed the basis for APEC’s NBIP.

The Beginnings of Investment Liberalisation as an APEC Agenda Item A review of the records of Ministerial Meetings since 1989 suggests that investment was originally included on the APEC agenda as an issue on which member economies might cooperate to enhance growth and

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Liberalising Foreign Direct Investment Policies in the APEC Region

development in the region. The initial meeting of Economic Ministers of the 12 founding economies of APEC in Canberra in 1989 linked investment, technology transfer and human resource development as measures that might bring about this aim. Specific suggestions concerned projects to facilitate trade, investment and technology transfer opportunities. These included identifying joint investment opportunities in individual sectors and other projects in which joint investment might occur, establishing regional chambers of commerce, and developing linkages at the individual enterprise level. Senior Officials were given the task of devising strategies to implement these ideas. The 1990 Ministerial Meeting in Singapore continued this theme by proposing two major projects in the areas of investment and technology transfer: the development of an investment and technology information network and dissemination of experiences of member economies in establishing technoparks. The rationale for the latter suggestion was that technoparks are effective vehicles to facilitate investment and technology transfer, thus dealing with both issues via a single project. By the time of the Seoul meeting in 1991, a proposal to develop a manual for managing technoparks in the region had been put forward and investigation of an investment and technology information network was under way. The Seoul meeting’s most significant contribution to the future direction of APEC’s work on investment was the Ministers’ declaration at the conclusion of their meeting. The Seoul declaration, as it has come to be known, noted the future goals of member economies as ‘developing strategies to reduce impediments to the flow of goods and services worldwide and within the region’ (APEC Economic Ministers’ Meetings Reports 1991). While impediments to investment were not mentioned specifically, this declaration set the scene for later, more specific development of the goal of investment liberalisation. The Seoul declaration also flagged the possibility that member economies might need to look more carefully at their individual policies if impediments were to be removed. The Ministers’ statement on this point could not have been put more diplomatically and indirectly with ‘APEC hopes to improve the understanding of policy concerns, interests and experience of economic partners... and help to promote consistency in policy making in appropriate areas’ {APEC Economic Ministers’ Meetings Reports 1991). Ministers also reaffirmed their commitment to economic cooperation at the Seoul meeting. The Declaration referred specifically to the need for promoting

The Investment Liberalisation Process in APEC

15

regional trade, investment and financial resource flows, human resources development, industry cooperation and infrastructure development. The Bangkok meeting in 1992 followed up on the Seoul declaration’s com m itm ent to removing impediments. Ministers directed Senior Officials to examine market access issues and prepare a report for reducing impediments. More directly significant for investment was the suggestion that a detailed guidebook be prepared setting out member economies’ regulatory procedures regarding investment. Publication of the guidebook would of course expose the extent to which barriers to investment existed within the region and therefore advance the cause of those who wished to see APEC move forward towards an agenda of liberalisation. This was aided by the existing initiatives on investment and technology transfer having largely run their course by the 1992 meeting. The working group on investment and technology transfer delegated the establishment of an Asia Pacific investment and technology information network to a group of experts and preparing the manual on developing industrial parks to Japan.

Liberalisation as a Firm Goal of APEC Until 1993, national governments tended to leave APEC issues predominantly to their Economic Ministers and Senior Officials. However, during 1993 and 1994 the range of participants in the process increased dramatically, significantly influencing the APEC agenda including issues related to investment. As noted above, the EPG, Pacific Business Forum, Leaders’ Meetings, the Committee on Trade and Investment, the IEG and the APEC secretariat were all established in the 1993-94 period. It is useful to carefully review chronologically the impact of these groups in establishing investment liberalisation as a major aim of APEC. The EPG presented its first report to Ministers in November 1993. The text of the report focuses predominantly on trade liberalisation with the goal of free trade in the Asia Pacific to be pursued as much as possible through multilateral processes. APEC was to assume a role of ‘ratcheting up the process of global trade liberalisation’ (EPG Report 1993: 2). This report said very little about the need to also liberalise investment. Rather, it noted the need for increased efforts to facilitate investment including the adoption of an Asia Pacific Investment Code. A number of Senior Officials’ Meetings were held in 1993 under the chairmanship of the US. As Bodde (1994) has noted, the Senior Officials’

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Liberalising Foreign Direct Investment Policies in the APEC Region

Meetings were and are the engine of APEC in the sense that these meetings receive various reports from APEC Committees, make recommendations to Ministers and push for implementing decisions in the various members’ economies. The most significant step towards investment liberalisation taken by Senior Officials in 1993 was the approval of a trade and investment framework. Ministers subsequently endorsed this framework at their November 1993 meeting. The Ministerial Meeting of 1993 was perhaps the major turning point for investment issues in APEC. For the first time, the report of the Economic Ministers’ Meeting linked trade with investment liberalisation as a major subheading in the report. Previously, trade liberalisation was a sub­ heading on its own and investment issues were dealt with under the section concerning the working group on investment, industrial science and technology transfer. Even more important was the report’s declaration that trade and investment liberalisation should be regarded as the ‘cornerstone’ of APEC’s identity and activity. The Ministers also noted that improving investment rules and procedures in a General Agreement on Tariffs and Trade (GATT) consistent manner were central to APEC’s objectives. The ‘Declaration on a Trade and Investment Framework’ approved by the meeting referred specifically to the link between trade and investment and the need to reduce trade and investment barriers. This declaration established the Committee on Trade and Investment to replace the former regional trade liberalisation committee. It also sets out the new committee’s objectives as presenting coherent views on global trade and investment issues, increasing cooperation on those issues and working to facilitate a more open environment for trade and investment. Ministers were to determine the work program of the Committee, which was to report to Ministers via the Senior Officials. The first APEC Leaders’ Meeting in Seattle in November 1993 made two major statements regarding investment. The first statement emphasised the need to continue reducing trade and investment barriers. The second concerned the need to have a non-binding code of principles covering investment issues. Thus, the events of 1993 saw the beginnings of APEC’s recognition of the goal of investment liberalisation. This was a marked departure from the previous approach to investment where investment issues were recognised only as an area where member economies might cooperate through facilitation measures. As their reports reveal, the 1994 meetings of the various APEC related bodies firmly entrenched investment liberalisation as a major goal in the

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APEC process. A major driving force for this move was the report issued by the Pacific Business Forum, a body established by the Leaders in Seattle. It comes as no surprise that business leaders’ reports are couched in more direct language than the diplomatically drafted texts of Ministerial and Leaders’ Meetings. The Pacific Business Forum argued that further trade and investment liberalisation and deregulation were essential for continued economic growth in the region. The Forum suggested the ambitious dates of 2002 for free trade and investment in developed economies in the region and 2010 for developing economies. They recommended that the proposed non-binding investment code become binding and incorporated into the laws of member economies as soon as possible, and that in the meantime there should be a standstill on introducing any new trade and investment barriers. In a direct message, the business leaders noted that business could not wait for governments and would go ‘wherever the bureaucracy was minimal and procedures straightforward and transparent’ (PBF Report 1994: 2). In other words, those economies that did not liberalise their investment regimes were likely to miss out on future investment flows. The EPG produced a further report in 1994, clearly linking trade with investment liberalisation. This was clear from the report’s title: ‘Achieving the APEC Vision: Free and Open Trade and Investment in the Asia Pacific’. The Report noted that free trade and investment were critical to the future of the Asia Pacific region and recommended that Leaders adopt the long-term goal of ‘free and open trade and investment in the region’ by 2020. Of major significance was the suggestion that the task of implementing policies to achieve this goal should commence during the year 2000. The thinking here appears to have been that it would require several years for member economies to actually gamer the necessary domestic support for the significant policy change necessary to begin the liberalisation process. This point seems to have been overlooked by those commentators who, in the latter half of the 1990s, have criticised APEC for failing to achieve significant steps in trade and investment liberalisation. The EPG also recommended adopting measures to facilitate trade and investment in the course of liberalisation. On investment specifically, the group again suggested an early adoption of a voluntary investment code. Having established the Committee on Trade and Investment in 1993, Economic Ministers appear to have been willing to delegate to it much of the discussion on investment liberalisation and facilitation. The 1994 Ministers’ Meeting welcomed the first report of the Trade and Investment

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Committee and endorsed the draft principles of the proposed investment code. The meeting also formalised the new emphasis on investment liberalisation by removing investment issues from the working group on investment, industrial science and technology transfer and including it as one of the three major functions of the Committee on Trade and Investment. A separate subcommittee - the IEG - was also established to report to the Committee on Trade and Investment. The report of the 1994 Leaders’ Meeting in Bogor clearly enunciated for the first time what has become known as APEC’s three pillars - trade and investment liberalisation, trade and investment facilitation and economic cooperation. The Leaders also took the significant step of endorsing the EPG goal of free and open trade and investment in the region by 2020, with developed economies to achieve this by 2010 and developing economies by 2020. The endorsement of free and open trade and investment provides a clear view of what is intended to be the end result of the liberalisation process. It is difficult to attribute to ‘free and open trade and investment’ any meaning other than the absence of all restrictions on trade and investment. We see then that by the end of 1994, the APEC process had defined clearly the meaning of liberalisation, the intended end result and the date by which this was to occur. The 1994 Leaders’ Meeting also endorsed the draft investment code. From here we will examine the provisions of the code with a view to determining the extent to which this code supports the liberalisation agenda.

The Non-binding Investment Principles The idea of developing an investment code for the region received significant attention from various APEC fora during 1993. In its 1993 report to the Economic Ministers, the EPG recommended an investment code as a useful device for facilitating investment flows in the region. The PECC developed a draft code during 1993 and presented it to the Senior Officials’ Meeting in November 1993 in Seattle. The idea for a code was accepted by the Leaders’ Meeting with directions to develop a non-binding code of investment principles. Negotiating the terms of the code took place through the newly formed IEG throughout the course of 1994. Leaders finally adopted this investment code at their meeting in Bogor in 1994.

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The actual terms of the NBIP appear to be modelled on the investment provisions of the NAFTA. In turn, these principles were derived from the provisions of the US model bilateral investment treaty. As I note below, the APEC NBIP are weaker than the NAFTA provisions and the model US treaty provisions. This is not surprising when we consider the very few bilateral investment treaties that the US has in force. Most countries are not prepared to adopt the US approach without some flexibility to safeguard their own national security concerns and development priorities. Commentators on the code including Bora (1996), Bora and Graham (1996) and Janow (1997) argue that the NBIP amount to a weak instrument for achieving a free and open investment regime in the region. Nonetheless all recognise the code as a useful first step towards this end. The Pacific Business Forum and its successor, ABAC, have continued to press APEC member economies to incorporate the code’s NBIP into their own domestic laws to make the code a binding instrument. By the end of 2000 this suggestion has not been accepted, indicating the considerable domestic political difficulties that member economies have in adopting a rules based investment regime. I explore these difficulties further in Chapter 3 while addressing constraints on further liberalisation. In its review of the provisions of the code in 1995, the EPG suggested that five of these provisions (transparency, non-discrimination, expropriation, settlement of investment disputes and tax measures) were the equivalent of international practice in investment treaties. However, the Group claimed that five provisions - relating to national treatment, performance requirements, investment incentives, repatriation and convertibility, and entry and sojourn of foreign personnel - failed to measure up to international best practice. The Group’s assessment says little about the role of the NBIP in pushing forward liberalisation. As I discuss below, even some of those principles that meet international standards leave room to achieve far less than a free and open investment regime. Let us consider each of the investment principles set out in the Investment Code and their strengths and limitations for achieving the liberalisation objective. This discussion makes it apparent that some of the NBIP relate to liberalising operational barriers more than formal entry barriers and that some principles deal more with facilitation than liberalisation as such. As noted in the introduction, this book deals primarily with investment liberalisation from the point of view of formal entry barriers.

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Transparency Member economies will make all laws, regulations, administrative guidelines and policies pertaining to investment in their economies publicly available in a prompt transparent and readily accessible manner.

This provision of the Code relates to both formal entry barriers and operational restrictions. As such, it presents the immediate difficulty that many laws of both the host and the home country affect most investments. In its broadest interpretation the provision appears to call for no less than the ready availability of all laws, regulations and administrative guidelines operating in each APEC economy. APEC members are moving in this direction with the Investment Guidebook published by the APEC secretariat serving as a useful guide on the laws most relevant to investment. Nonetheless, the information provided in the guidebook depends on the information that member economies provide to the secretariat. A review of the information in the guidebook shows that some member economies are more diligent than others in providing comprehensive information. Further, the guidebook contains summaries of the effects of the laws and regulations and not the regulations themselves. This means that interested parties must consult various sources for laws that exist in each member economy. As more economies move to have their laws available on line, problems in this area (other than language difficulties) are likely to diminish over time. The term ‘transparency’ itself is open to various interpretations. We could argue that publishing the various investment laws and regulations and acknowledging problems due to the magnitude of the task - is only a first step towards a truly transparent legal order. Ready access to laws and regulations is of little use to an investor if those laws and regulations are drawn in such broad terms that the people or institutions that apply these laws and regulations have wide discretion in their application and if the exercise of this discretion is not open to challenge. It will become apparent that many countries’ laws relating to foreign investment deliberately allow wide discretion to domestic investment authorities because of the politically sensitive nature of foreign investment. Further, many member economies are reluctant to allow independent authorities to review the exercise of this discretion because sensitive ‘national interest’ considerations are involved in the decision.

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The foregoing issues might assume less significance in the longer term if ‘transparency’ is considered only in terms of formal barriers to entry and establishment. This is because a truly free and open investment regime implies minimal barriers to entry and, as liberalisation proceeds, these barriers will be removed. However, if transparency is defined more broadly to cover not only the initial laws, regulations and administrative procedures that investors face when seeking to establish a business but also the numerous laws that apply to the day to day business operations of the investment, then transparency depends on the approach to regulation in each individual economy. If current trends towards deregulation continue, then laws affecting business operations should, in theory, also decline in effect. This would allow for drawing up the laws more narrowly to give less discretion to those who administer these laws. The work involved in achieving a transparent investment environment is thus bound up intimately with broader questions of governance. Non-discrimination Between Source Economies Member economies will extend to investors from any economy treatment in relation to the establishment, expansion and operation of their investments that is no less favorable than that accorded to investors from any other economy in like situations, without prejudice to relevant international obligations and principles.

In accordance with APEC’s key principle of open regionalism, a free and open investment regime seems to imply that non-APEC as well as APEC members should have equal right to establish a business in any of the APEC member economies. The concept of open regionalism is firmly grounded in the economic principle that suggests openness to trade and investment is beneficial even though such openness may not be reciprocated. It may be possible to demonstrate this principle in theory, but the principle is difficult to implement politically and for that reason may take some time to be enshrined in the domestic legislation of APEC member economies. Further, the wording of this non-discrimination provision grants an exception based upon relevant international obligations and principles. This appears to be designed to exempt NAFTA, MERCOSUR (Southern Common Market), AFTA (ASEAN Free Trade Area) and CER (Closer Economic Relations - Australia and New Zealand) members of APEC

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from having to grant to other APEC members the more favourable treatment that members of these groupings give to each other. National Treatment With exceptions as provided for in domestic laws, regulations and policies, member economies will accord to foreign investors in relation to the establishment, expansion, operation and protection of their investments, treatment that is no less favorable than that accorded in like situations to domestic investors.

This is arguably the most important provision of the NBEP for achieving a liberalised investment regime in the region. The cornerstone of a liberalised investment regime is the absence of distinction between domestic and foreign investors. The provision advances this aim by its breadth, covering not only initial barriers to entry but also the expansion, operation and protection of the business. In terms of seeking to afford foreign investors the same conditions as those that apply to local investors throughout the business life of their investment, the national treatment provision is unusually progressive (UNCTAD 1999b). However, unlike the more detailed provisions of the NAFTA agreement, we do not find here the requirement that member economies state specifically which industry sectors are exempt from national treatment. The investor must search through each individual economy’s laws, regulations and policies to discover which sectors are reserved for nationals or impose some special conditions upon foreign investors. Both the NAFTA investment provisions and the General Agreement on Trade in Services (GATS) require each member country to set out in schedule form the areas that are excepted from national treatment. The APEC Investment Guidebook is the mechanism for listing the exceptions to national treatment. While the guidebook fulfils this function reasonably well, the information that member economies provide for publication in the guidebook is uneven and on occasions this information is not specific enough to enable investors to determine the conditions upon which they will be permitted to invest in industries that are exempt from national treatment. As I note in the following chapter, many of the sectors exempted from national treatment fall into the service area. It should therefore be possible in time for the Investment Guidebook to provide the more

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comprehensive listings as set out in individual member economies’ schedules to the GATS. Establishing a clear picture of which areas are exempt from national treatment is a first step towards removing those exemptions. The APEC process for removing the exemptions is the action plan process that I discuss in more detail in the following section. However, at this point it needs to be noted that ABAC has consistently criticised the individual action plans of member economies for being too vague on timetables for achieving broadly based national treatment (ABAC 1998: 72, 1999: 4-5). Investment Incentives Member economies will not relax health, safety and environmental regulations as an incentive to encourage foreign investment.

I argue at length in Chapter 4 that this is the weakest of the investment principles. A number of observers (Shah 1995; UNCTAD 1996) have argued that in the race to attract foreign investment, countries are offering more and more generous fiscal incentives. This applies not only to developing countries but also to developed economies. In the APEC process incentives offered by developing economies tend to be more exposed because they are offered on a national level and following principles of transparency and self interest are made quite explicit. However, in some of the more developed economies, governments offer incentives at a sub-national level. Here it is often the case that neither the conditions upon which incentives are granted nor the incentives themselves are made public. For the most part, governments at the national level turn a blind eye to this practice. As I argue later, most observers see the provision of incentives as a significant waste of resources. Incentives are rarely effective in luring investment and when they are effective they can distort the pattern of investment from that which would have eventuated in their absence. It seems clear that those drafting the NBIP put the issue of investment incentives into the too hard basket and there appears to be little momentum to bring the issue back onto the APEC agenda. Nonetheless, a truly free and open investment regime implies that the playing field between member economies will be level. Thus the elimination of incentives should be a goal equally as important as the removal of barriers to entry. There is a danger that if no action is taken to limit incentives, then, as barriers come

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down, member economies will attempt (albeit ineffectively in many cases) to rely on incentives to steer investment into politically desirable sectors of the economies. Perhaps for this reason some observers (Chia 1994) advocate adopting standstill and rollback provisions on incentives as well as performance requirements. Performance Requirements Member economies will minimize the use of performance requirements that distort or limit the expansion of trade and investment.

The elimination of what are usually categorised as performance requirements is also subject to the GATT Agreement on Trade Related Investment Measures (TRIMs). The TRIMs’ agreement requires all GATT members to eliminate conditions imposed on investors that have the effect of distorting trade. The offending measures are generally listed as local content rules, trade balancing requirements, requirements to transfer technology, to export a certain percentage of production or to export to a particular market (Price and Bryan 1995; Janow 1997). These measures are generally imposed on investors as part of their conditions of approval. Developed country members are expected to have abolished performance requirements within two years of acceding to the TRIMs’ agreement, developing countries within five years, and least developed countries within seven years (Urata 1998). Examination of the performance requirements specifically listed by member economies in the APEC Investment Guide reveals that most members either state that there are no such requirements in their economy or that these requirements exist only in very limited industries such as the automobile industry. Yet, as I discuss further in Chapter 2, many member economies still reserve the right to approve all investment and are therefore able to impose performance requirements on investors as part of the conditions of approval. APEC’s 1998 survey of business views concerning impediments to investment in the region found that the existence of performance requirements was a major impediment. It can therefore be argued that to achieve a free and open investment regime in the region, more is required than members ‘minimising’ the use of performance requirements. As the EPG found, the provision on performance requirements in the NBIP is therefore below comparable

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international standards and, as Janow (1997) argues, it also fails to meet the GATT obligations of APEC member economies. Expropriation and Compensation Member economies will not expropriate foreign investments or take measures that have a similar effect, except for a public purpose and on a nondiscriminatory basis, in accordance with the laws of each economy and principles of international law and against the payment of prompt, adequate and effective compensation.

This provision of the NBIP aims at facilitating rather than liberalising investment. Its inclusion stems from the fact that many investments are long-term and before making such a commitment, foreign investors need to be confident that their property cannot be taken by the state other than for public purposes and then only if prompt adequate and effective compensation is paid to them. This provision adopts the highest international standards with regard to expropriation and compensation. Agreement on this principle seems surprising given the historical difference of opinion that has existed concerning this issue. In the past, Latin American countries subscribed to the Calvo doctrine that asserted foreign investors were entitled to no more protection than local investors and were subject entirely to the jurisdiction of local courts if any dispute arose concerning the state taking the foreign investor’s property. The more advanced industrialised economies subscribed to a different view of state responsibility: that property of foreign investors should be expropriated only for a public purpose, in accordance with due process of law, and that prompt adequate and effective compensation had to be paid to them. This is the well known Hull formula. Developing countries adopted yet a third position. This was that states should have the right to take property if it is in the national interest to do so and while compensation should be paid this needed to be only that which was ‘appropriate’ in all of the circumstances. A cynical view of this provision is that it was accepted by many APEC economies only because of its non-binding nature. This view is reinforced if one examines the provisions of the more binding bilateral investment agreements that are in force within the region. Sonorajah (1995) has pointed out that it is difficult to find a uniform compensation standard among them. Some agreements tend to make foreigners’ property rights

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subject to foreign investment laws as they exist from time to time, or protect only foreign investment operating in accordance with the law of the state. This leaves it open to the state to change its laws and change the conditions upon which foreign investment will be protected. Of course, the current competition for foreign investment makes it unlikely that states will damage their international reputation among investors through rash expropriations. However, it is possible that international trends will reverse and we may again witness a resurgence of economic nationalism and expropriations. Foreign investors are no doubt aware of this possibility and for that reason want this provision of the NBIP incorporated into domestic legal orders. However, if actual state practice in the 1970s is anything to go by, even adopting the Hull formula will not guarantee investors compensation on prompt, adequate and effective terms. Some studies of expropriation at that time show that more often than not, the compensation that investors actually received met neither the prompt nor the adequate standard, with adequate being defined as ‘fair market value’. More often than not expropriations resulted in negotiated settlements with foreign investors for appropriate compensation. Norton’s (1991) analysis of the decisions of international tribunals showed that while the Hull formula was accepted as the international law position in most instances, there were many variations in its application to determine the actual award of compensation. In the absence of any trend towards expropriation in the region, it is difficult to determine how this provision in the NBIP will be applied in practice. Of course, any return to a trend towards expropriation would significantly undermine the advantages in terms of increased investment flows resulting from a more liberalised environment. For that reason member economies may be reluctant to resort to expropriation other than on the terms proposed. Repatriation and Convertibility Member economies will further liberalize towards the goal of the free and prompt transfer of funds related to foreign investment such as profits, dividends, royalties, loan payments and liquidation, in freely convertible currency.

This provision deals with the operational aspects of foreign investment projects more than the formal barriers to entry with which this work is mostly concerned. I noted earlier that the EPG found this provision to be

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weaker than comparable international standards primarily because it appears to allow member economies to move at their own pace towards totally free movement of capital flows related to foreign investment projects. While most economies in the region have now adopted Article 8 of the International Monetary Fund (IMF) provisions related to free movement of capital, many of these economies still have onerous bureaucratic requirements in place and some have not yet adopted freely convertible currency regimes. The repatriation and convertibility provision seeks the removal of these restrictions. Settlement o f Disputes Member economies accept that disputes arising in connection with a foreign investment will be settled promptly through consultations and negotiations between the parties to the dispute or failing this through procedures for arbitration in accordance with members’ international commitments or through other arbitration procedures acceptable to both parties.

Once again, this provision is more a facilitation measure for foreign investment rather than a measure related to liberalisation. As the NBIP purport to be an agreement among states, this provision needs to be interpreted as referring to foreign investment disputes between states themselves or perhaps between a state and a foreign investor. It is unlikely that the provision refers to purely private disputes between business entities. The most commonly accepted forum for resolving state-foreign investor disputes is the international arbitration institution established under the International Convention for the Settlement of Investment Disputes (ICSID). This provision does not go so far as to name ICSID but the reference to members’ international commitments implies that those economies that are also members of ICSID will use that forum. The provision also takes account of traditional East Asian preferences for informal resolution of disputes by specifically requiring consultations and negotiations prior to more formal dispute resolution procedures.

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Entry and Sojourn o f Personnel Member economies will permit the temporary entry and sojourn of key technical and managerial personnel for the purpose of engaging in activities connected with foreign investment, subject to relevant laws and regulations.

The quality of the day to day management in a foreign investor’s business is one of the key determinants of business profitability. This provision is included in recognition of this understanding. One of ABAC’S earlier recommendations was to free up the movement of business people within the region to facilitate trade and investment flows. The difficulties that member economies face here is the need to maintain some control and monitoring over people entering and leaving their borders and to balance these legitimate concerns with the desire to facilitate business. When we consider each member economy’s entry in the Investment Guidebook we find that the provisions relating to the stay of foreign personnel are often the most lengthy and complex part of the entry. Further examination reveals that each economy has its own system for issuing visas and work permits, with little standardisation evident across the region. A precursor to any liberalisation here may be some degree of policy harmonisation. This in itself will be a difficult task as it involves convincing traditionally conservative ministries of immigration of the need for change. Avoidance o f Double Taxation Member economies will endeavor to avoid double taxation related to foreign investment.

This is a further provision to facilitate investment flows. Surveys of business in the region continue to show that along with entry of personnel, trade restrictions and performance requirements, the complexities and inconsistencies of taxation systems are a major operational hurdle to conducting business successfully. Some harmonising of double taxation provisions would be a useful step but this is complicated by the differences between economies concerning their taxation of various types of foreign business presence. The provision itself is weak in that it appears only to encourage the formation of double taxation agreements rather than attempt to harmonise

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their provisions. For this reason ABAC has made a number of recommendations on the issue. Investor Behaviour Acceptance of foreign investment is facilitated when foreign investors abide by the host economy’s laws, regulations, administrative guidelines and policies just as domestic investors should.

It has been a constant theme in forums such as the Organisation for Economic Cooperation and Development (OECD), UNCTAD and the World Trade Organisation (WTO) that foreign investors’ obligations as well as their rights should be part of any multilateral discussion on foreign investment and the inclusion of this provision attempts to reflect this. Removal o f Barriers to Capital Exports Member economies accept that regulatory and institutional barriers to the outflow of investment will be minimized.

This provision acknowledges the need to reduce not only barriers to inward investment but also any barriers that might exist on outward investment. This review of the provisions of the NBIP suggests that the principles dealing with national treatment, non-discrimination, transparency, incentives and performance requirements are most significant for removing formal barriers to entry. The other principles are more applicable to the operational environment faced by foreign investors and to a considerable extent by domestic investors as well. At this point we turn to discuss the complex matter of implementing those principles that are most relevant to removing formal entry barriers.

The Action Plans At their 1994 meeting in Bogor, Leaders directed Economic Ministers and Senior Officials to prepare detailed proposals for the implementation of their decision to achieve a free and open investment environment. The Leaders expressed their desire that the views of the EPG and the Pacific Business Forum be taken into account in the process. As a result, Senior

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Officials developed the framework for action plans. These plans were to put in place specific measures that could be taken by individual economies and by APEC collectively to promote trade and investment liberalisation, trade and investment facilitation and economic cooperation. They are known as the individual action plans and the collective action plans respectively. The starting point for developing this framework was to formulate underlying principles that would guide the specific measures in the action plans. These principles are set out in detail in the 1995 report of the EPG. They were endorsed with minor amendments by Economic Ministers and then by the Leaders’ Meeting in Osaka (APEC Osaka Action Agenda 1995). The principles have significant bearing on proposed actions to be taken on investment liberalisation and therefore require some discussion here to highlight their relevance in this regard. The first of the agreed principles is comprehensiveness. For investment liberalisation this requires members to take action to liberalise across all sectors rather than making liberalisation efforts on a piecemeal basis. The second principle is WTO consistency. Recognising the complementary efforts made by the WTO to liberalise trade on a global basis, this principle requires that the actions taken by APEC members in this regard should be WTO consistent. An important implication for investment is that the removal of performance requirements should occur in line with the TRIMs’ agreement. As noted earlier, the NBIP were weaker than the TRIMs’ requirements. The effect of the principle regarding WTO consistency should be to boost the elimination of APEC performance requirements to at least WTO standards, possibly curing this weakness in the NBIP. The third principle is comparability. This principle aims to ensure that trade and investment liberalisation is achieved evenly across the region with all member economies undertaking similar efforts, while recognising differences in the degrees of liberalisation that member economies have achieved already. Non-discrimination is set out specifically as a fourth principle to guide action. The requirement to reduce barriers not only among APEC member economies but also in the rest of the world is mentioned specifically as the fifth principle. These principles echo the requirement of the NBIP that member economies make their laws, regulations and administrative guidelines transparent. The sixth principle is standstill, which also boosts the NBIP. It requires member economies not to introduce new measures that would have the effect of increasing already existing barriers. The following two principles

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acknowledge the different levels of economic development of member economies and as a result recognise that while liberalisation efforts should begin simultaneously in all economies, the pace of liberalisation may need to take into account the circumstances of individual economies. The implications for investment liberalisation are that developing economies may well refrain from opening some sectors too quickly if they believe that this will have an adverse effect on their economic development. I discuss further the difficulties that this poses for the liberalisation process in Chapter 3. The final principle enshrines the original goal of APEC in that economic and technical cooperation should accompany liberalisation measures. As noted above, the framework for the action plans was divided into two main areas - individual actions and collective actions. Individual and collective actions are to take place across a broad range of areas including tariffs, non-tariff measures, standards and conformance, customs procedures, investment, intellectual property rights, competition policy, government procurement, deregulation, rules of origin, dispute mediation, and mobility of business people. On investment the Osaka Action Agenda notes that the overall goal is to achieve free and open investment in the region by individual economies liberalising their investment regimes and by taking actions to facilitate investment flows. The Action Agenda requires each individual economy to ‘progressively reduce or eliminate exceptions and restriction to achieve the above objective, using as an initial framework the WTO Agreement, the APEC NBIP, any other international agreements relevant to the economy and any commonly agreed guidelines developed by APEC and to explore expansion of the network of bilateral investment treaties’ {APEC Osaka Action Agenda 1995: 12). On collective action, the Osaka Action Agenda notes specifically the need for maintaining and updating the Investment Guidebook, ongoing dialogue with the business community to improve the investment environment, organising training programs to facilitate technical cooperation in investment matters and dialogue with the investment arm of the OECD. The Agenda also urges an evaluation of the role of investment liberalisation in economic development, an examination of the common elements of sub-regional arrangements regarding investment and refining in the medium term APEC’s understanding of ‘free and open investment’. The framework put forward by Senior Officials was accepted at the Osaka meeting and at the following Leaders’ Meeting in Subic Bay in 1996. It was agreed that each individual economy should present its action plan

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for achieving liberalisation in each of the areas including investment. Each of the APEC groups were to submit their plan on how to achieve the agreed collective measures. The action plans have been updated every year since 1996 and in 1999 the PECC was requested to undertake a review of the individual action plans to determine the strengths and weaknesses of the process in achieving APEC’s three major goals. At the same time, member economies have been encouraged to submit their individual action plans for peer review. A number of the more developed economies submitted their plans in 1998 and several more economies submitted their plans in 1999. I continue discussion of the individual action plan measures relating to investment in Chapter 2 where I offer an overall assessment of the degree to which investment liberalisation has occurred in the region. At this point, however, it is useful to note some general criticisms that ABAC has made of the individual action plans. ABAC (1999: 5) points to two specific needs in individual action plans. One is the need to be more transparent in setting out the steps that economies intend to take to achieve liberalisation and the policy intention behind those steps. The other is the need to be more specific as opposed to making vague suggestions about ‘adhering to the non-binding investment principles’. ABAC recommended that specific liberalisation measures and timelines for achieving these should be set out in the plans. It also recommended that the contents of the action plans be made more user friendly; accessing individual action plans from the APEC web site is not user friendly and even when accessed the plans present the reader with a maze of tables to be sorted through to find relevant information. ABAC also suggested that the action plans were not comprehensive in that they did not take into account liberalisation measures that had been adopted since the Asian financial crisis in 1997. At the same time ABAC has acknowledged that many member economies have taken some steps towards implementing liberalisation measures. In its 1999 report to Leaders, ABAC noted that 13 economies included some commitment to investment liberalisation in their action plans. In its review of the Action Plan process, the 1999 Economic Ministers’ Meeting noted that 17 member economies undertook some liberalisation of their investment regimes since 1996 and that in some cases the liberalisation had drawn on the menu of options (discussed below). More significant was the comment that little backsliding was evident in the overall Action Plan process. Notwithstanding, Ministers directed that

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further work be carried out to ‘improve the transparency of action plans and to develop improved guidelines for member economies to show how they intended to achieve the Bogor goals’ (APEC Economic Ministers’ Meeting 1999: 1). In other words, Ministers also appeared to be slightly disappointed with the absence of detail shown by member economies on liberalisation generally and the proposed timing of liberalisation. Given that all of the major players in the APEC process (Leaders, Economic Ministers and ABAC) have voiced similar criticisms of the individual action plans, we might conclude that there are significant political constraints at the domestic level in implementing the APEC vision. We will return to this matter in Chapter 3. Investment liberalisation was one of the few areas of the individual action plans singled out for specific criticism by the ABAC Action Plan Monitoring Committee in its 1999 report. ABAC noted the window of opportunity that the crisis presented for investment liberalisation in the region. While applauding the development of the menu of options for investment liberalisation developed by the IEG, ABAC points out bluntly that business needs more in individual action plans than promises to implement the NBIP. ABAC claims that concrete liberalisation initiatives need to be set out along with a timetable for their implementation. These criticisms suggest that translating good intentions into concrete action is very difficult in the investment area. ABAC’S frustration here is evident from a proposal it made in 1996 that economies select particular sectors for early investment liberalisation - the APEC Voluntary Investment Project initiative (ABAC 1996). This proposal was refined in 1997 to produce a set of principles that member economies might adopt in their treatment of foreign investment in infrastructure. A cursory examination of the principles shows that ABAC was essentially recommending that the NBIP be implemented immediately by member economies for infrastructure projects. On the basis of ABAC’S 1999 report that set out all of its past recommendations and how these have been acted upon, it is clear that the infrastructure investment initiative has received little response other than in the energy area and this has been largely due to the initiatives of the Energy Working Group (ABAC 1999: 69). A review of the implementation of APEC’s collective actions including those relating to investment was also undertaken in 1999. This highlights how in the investment area the collective actions of APEC have been far more successful than individual actions. The review clearly sets out the measures taken to implement each of the points set out in the Osaka

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framework, largely through the commendable efforts of the APEC secretariat and the EG . APEC has kept the Investment Guidebook updated, it has held a number of successful seminars with the business community on improving the investment environment, and has arranged a wide range of training programs to further the aim of technical cooperation in the investment area. APEC has also prepared a report on the role of investment liberalisation in economic development and has consulted on investment matters with other organisations including the OECD, the WTO and UNCTAD. All of these measures have improved the understanding of investment issues by government officials and to some extent by business in the region. Perhaps the most commendable achievement was the menu of options to assist individual economies with including specific measures in their individual action plans, which I discuss in more detail below. However, the collective actions taken by APEC have been lacking in one major respect and that is to define more precisely what a ‘free and open’ investment regime means. A literal interpretation suggests the complete absence of any barriers to the movement of investment from one economy to the other. Yet, it is immediately apparent that even after the 2020 deadline there will inevitably be some sectors in all economies where foreign investment remains tightly controlled. It may well be that defining these areas needs to take place further down the liberalisation path in the light of evolving international economic developments.

The Menu of Options At their meeting in Canada in 1997, the E G agreed to a suggestion from the US that a menu of options be developed to provide APEC economies with a list of possible measures that they could adopt to move investment liberalisation forward. The list of suggestions was subsequently endorsed by Economic Ministers in Vancouver and ABAC has commended this list. It sets out measures under each of the major N BE - transparency, non­ discrimination, expropriation and compensation, and so forth (APEC 1998). The framework I have adopted for analysis here is to group the suggestions under the various criteria I use in Chapter 2 to discuss the current state of liberalisation in the various APEC economies. As noted earlier, these headings relate primarily to the liberalisation of formal entry barriers. There are many suggestions in the menu of options that concern

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the approval process, sectoral restrictions and ownership requirements. The list also contains measures aimed at improving the operating environment within host countries. Since the focus of this book is formal entry barriers, I consider measures to improve the operating environment for business in less depth in the following section. All the recommendations in the menu of options concerning approval processes aim to reduce the need for foreign investors to be subjected to screening processes beyond those that apply to domestic investors in the same industry. Thus, the menu contains suggestions that APEC economies phase out authorisation requirements altogether, or at least make approvals automatic except in a limited number of specified sectors. A further alternative is to limit formal approval to only major investments. Another suggestion is that if screening is used for some foreign investments, then the guidelines and criteria should be made explicit. The menu of options clearly seeks to have member economies reduce the number of industry sectors that exclude foreign investors or impose conditions on foreign investors over and above the conditions that apply to domestic investors. Under the subheading of ‘Sectors’ the menu lists six specific suggestions for removing sectoral restrictions. However, the suggestions are really six different ways of making the same point. This is that member economies progressively extend national treatment over more and more industry sectors and that this process should begin immediately. In terms of ownership limitations, the suggestions are aimed at giving foreign investors, rather than investment authorities, the right to decide upon the level of ownership that these investors want in their particular investment. There are suggestions that economies phase out joint venture requirements. Other suggestions are to eliminate conditions that allow greater levels of foreign ownership if the venture exports a certain percentage of its production and to eliminate restrictions on foreign branches as opposed to subsidiaries. There are also suggestions that foreign investors should not be required to divest any portion of their investment at any time in the future and, once having made an investment they should be free to expand into other areas. As noted earlier, the menu goes beyond measures to remove formal entry barriers and extends to operational matters. There are suggestions that economies clarify all licensing procedures by providing simple instructions on how to obtain a license and on the criteria that need to be satisfied. This is a significant suggestion because often after obtaining formal approval for their investment, foreign investors are then confronted

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with the task of visiting ministry after ministry to obtain permission for various aspects of their day to day business operations. Of course domestic investors also need to obtain such permission but they often find this easier than their foreign counterparts do because they are much more familiar with local bureaucratic systems. The menu even suggests that economies establish one-stop shops where all licenses and permits can be obtained. In a step that allows for sharing information and ideas, the IEG has encouraged this initiative by presentations from various member economies on the operation of their own one-stop shops. Further significant suggestions concerning removal of operational restrictions include eliminating restrictions on foreign and local borrowing by foreign investors, removing discriminatory restrictions on imports needed to support foreign investment, removing all restrictions on foreign investors regarding the transfer of funds in and out of the country in the currency of their choice, removing all performance requirements and granting foreign investors the right to bring in senior management and personnel. All of these measures have the support of business. The second APEC business survey in 1998 identified that what foreign investors see as the major operational barriers fall into the five areas just mentioned. The menu of options clearly supports liberalisation in terms of the removal of barriers. Yet it is somewhat disappointing on the other half of the liberalisation equation - the removal of investment incentives. Instead, the menu of options exhorts member economies to make the incentives that they offer voluntary, non-discriminatory and limited in duration. The range of incentives suggested includes tax breaks, loan guarantees, grants, subsides, industrial bonds, employment training programs, high technology development programs, measures to support the development of new industries and industrial linkage programs. As noted earlier, the removal of barriers without the complementary removal of investment incentives may have significant adverse economic and social consequences, a point that I expand upon in Chapter 4.

Conclusion APEC has a solid structure in place to support its objective of investment liberalisation. At the working level, the IEG composed of representatives from each economy’s investment agency develops ideas that might be adopted by member countries to implement liberalisation. Endorsement by

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Senior Officials via the Trade and Investment Committee and then Economic Ministers’ Meeting and finally the Leaders’ Meeting adds weight to these proposals. Without the endorsement by these peak bodies, it would be difficult for the process to move forward. It is clear that much of the concrete work on investment liberalisation in APEC has taken place since 1993. At that time, the whole APEC process received a significant institutional boost provided by the formation of the IEG but more importantly from other key bodies such as the EPG, the Pacific Business Forum and Leaders themselves, recognising the importance of accompanying trade liberalisation with similar initiatives in the investment area. Although the liberalisation initiative is relatively recent, some significant steps have been taken at both the individual economy level and at the collective level. At the individual economy level, it has been noted that 17 of the APEC member economies have implemented some liberalisation initiatives for FDI. APEC’s initiative in agreeing that individual action plans be developed may have prompted members to take these steps. Yet we see in the following chapter that much remains to be achieved if the goal of a free and open investment environment is to be achieved by 2010 for developed economies and 2020 for developing economies. Much more has been achieved at the collective level. Perhaps the most significant step has been the adoption of APEC’s NBIP. As noted in this chapter, these principles are drawn very broadly and encompass matters relating not only to the removal of formal entry barriers but also to operational matters. Those principles most relevant to the removal of formal entry barriers include transparency, non-discrimination, national treatment, performance requirements and incentives. The principles need further refinement. The precise meaning of transparency also needs to be clarified and the national treatment principle could be tightened to require countries to provide schedules of exceptions to that principle. This might be accomplished through a rethinking of the format of the Investment Guidebook. The Investment Guidebook is structured along the same lines as the NBIP. Its compilation relies on the information that member economies provide. The breadth of information required and the use of categories paralleling the NBIP results in some member economies glossing over the most significant issues in liberalisation - the removal of screening processes, sectoral restrictions, ownership limitations, incentives and performance requirements. If transparency is to be achieved, it may be

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necessary to adopt more specific headings in the Investment Guidebook and to request member economies to provide detailed schedules of exemptions from national treatment. These schedules could list major industry groups and provide for each group any conditions that exist in terms of screening requirements, foreign equity limitations, other special conditions, performance requirements that may be imposed, incentives that might be granted together with action under way to remove any restrictions and incentives in line with the menu of options. Such a process might assist in making restrictions much more transparent at an individual industry level. It would also expose exceptions to national treatment and make any cases of discrimination explicit. Assessments of the extent of performance requirements may then be made more easily and may also prompt some action on investment incentives. The need to restructure the guidebook will become more apparent from discussion in the following chapter. Other initiatives at the collective level have also assisted liberalisation. These initiatives have improved understanding of investment in the region. Investment symposiums, training for investment agency staff, investment marts and communication with other international organisations involved with foreign investment policy have all contributed to investment facilitation. In the end these moves may play a significant role in investment liberalisation by contributing to greater understanding of its benefits.

2 The Current State of Foreign Investment Policies in the APEC Region Introduction Each APEC economy has tailored its foreign investment policy in accordance with its economic circumstances and internal political situation. While there are some similarities between APEC member countries at similar levels of economic development, meaningful comparison on a cross-country basis is very difficult. Therefore, this chapter provides a summary of the foreign investment policy of each APEC member economy, applying a common set of criteria to evaluate the current state of liberalisation. In this chapter, I have divided the APEC member economies into four categories - developed economies, NIEs, developing economies and transition economies. The developed economies include the US, Canada, Japan, Australia and New Zealand. The NIEs are those with newly acquired OECD status or that are close to meeting all requirements for this status. They are Korea, Taiwan, Singapore, Hong Kong and Mexico. The developing economies are the remaining ASEAN members of APEC as well as the two southern Latin American members: they are Indonesia, Malaysia, Thailand, the Philippines, Papua New Guinea, Brunei, Chile and Peru. The transition economies are those making the transition from a centrally planned economy to a market economy. They are China, Vietnam and Russia. I categorise the member economies of APEC into these four groups because the foreign investment policies of the members of each group share more similarities with each other than with those outside the group, due primarily to the level of economic development. This chapter examines only those aspects of foreign investment policy that have been referred to previously as formal entry barriers, including approval requirements and sectoral and foreign ownership limitations. Sectoral restrictions have five categories: agriculture and land, natural resources, manufacturing, general services and sensitive services. 39

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Agriculture and land refers to all industries involved with agricultural production as well as ownership of both urban and rural land. Natural resource industries include mining, forestry and fishing. Manufacturing industries include all industries that produce goods. General service industries are primarily retailing, wholesaling, construction, tourism and other services that do not fit into sensitive service sectors. Sensitive service sectors are media, transport, energy production and distribution, finance and telecommunications. The discussion of foreign investment policy for each economy focuses primarily on the sectors that continue to have restrictions applying to foreign investors as opposed to domestic investors. It assesses the extent to which each economy has either general or specific approval requirements for industries in the five categories and sets out the extent to which performance requirements are imposed on foreign investors. It is difficult to be specific on the latter because where investment needs to be approved, performance requirements can be imposed as a part of the approval process. Also some economies are not forthcoming about these performance requirements in their entries in the Investment Guidebook. This chapter concludes with comments on future plans for further liberalisation. The previous chapter identified national treatment, non-discrimination, transparency and the removal of performance requirements as the most relevant of the NBIP that apply to liberalising formal entry barriers. Assessment of each country’s foreign investment policy therefore looks at the extent to which policy complies with these principles. Information on approval processes and sectoral and ownership restrictions is drawn primarily from each economy’s entry in the Investment Guidebook but where this is insufficient other sources have also been consulted. In many cases the investment information provided via a web page is far more detailed than the information in the Investment Guidebook. This points to the clear need for the Investment Guidebook to be more comprehensive if principles of transparency are to be met.

The Developed Economies We will begin with some general observations that clarify understanding of the detail set out below for each economy. At the outset, it is immediately apparent that the older industrialised economies have most restrictions in

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the agriculture, land and sensitive service sectors. There are also some restrictions in resource based industries but relatively few in general services and manufacturing. A concern to us here is that where industries are restricted not all economies provide details of the criteria upon which entry will be allowed. Predominantly this is left to broad considerations of national interest or a net benefit test. Even here the depth of information is uneven in the Investment Guidebook. Canada and New Zealand set out in general terms the criteria that foreigners seeking to enter restricted industries must satisfy, while Australia says simply that investments will be assessed in terms of the national interest as determined by general socio-economic concerns. Closely related to this is the requirement in Canada, Australia and New Zealand that all investment over a certain amount needs approval. In effect, then, investment agencies in all three economies have significant discretion in terms of approval of major investments and investments in listed restricted industries, meaning there are still significant limitations on national treatment of foreign investors. The two major economies in this group are at either end of the spectrum in terms of sectoral restrictions. In the US, the absence of a special approval system for foreign investors and the relatively few restricted sectors show in most cases little scope for the bureaucracy to provide other than national treatment. However in a number of sectors in the US, foreign investment is subject to reciprocity requirements that tend to offend the non-discrimination principle. Japan has a relatively extensive list of sectors where approval is effectively required, in accordance with its traditional approach to foreign investment. Alongside the absence of specific criteria, this results in the bureaucracy having considerable discretion concerning foreign investment in major sectors of the Japanese economy. Since the Osaka Action Agenda was initiated, all economies in this group have taken initiatives to liberalise their investment regimes. Australia and New Zealand extensively reviewed their foreign investment policies in 1999 leading to policy changes in terms of the threshold above which investment needs to be approved, the conditions relating to investment in land, and the level of foreign ownership in the airline industry. Japan has made its mining industry and some sections of its telecommunication industry no longer subject to prior approval. The US has lessened the strict requirements of the Foreign Reserve Board on conditions of entry of foreign financial institutions (Friesen and

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Nissenbaum 1998) while Canada has proposed some changes in the financial sector. Nonetheless, only Japan’s action plan suggests that the government will undertake further reviews of restricted sectors over the medium term to determine which can be liberalised but the plan fails to provide a timetable or specific details. No other economy’s action plans indicate the extent of any further liberalisation, reporting instead on the liberalisation carried out in the recent past. United States The US has traditionally had a liberal foreign investment policy in terms of both approval requirements and national treatment for foreign investors. Thus, for the most part, when foreign investors invest in the US, they need to comply only with the various regulations relevant to their particular industry and general regulations relevant to domestic corporations. However, in some circumstances the US President can block foreign investment. There are also some limitations - primarily reciprocity restrictions - on foreign investors in specific sectors, predominantly in the sensitive service sectors. The 1988 Exon-Florio amendment to the Defence Production Act allows the President to block proposed mergers and acquisitions (M&As) if there are grounds to believe that the M&As will adversely affect national security. This amendment therefore has the potential to act as a de facto screening mechanism (Kang 1997). The procedure allows Congress to request the Committee on Foreign Investment of the United States (CFIUS) to investigate whether a proposed merger will adversely affect national security. The Committee decides whether to investigate the complaint and if an investigation finds there are grounds to block the merger, it refers the matter to the President. Of 1,150 requests made to the CFIUS only 17 have been investigated - resulting in seven withdrawals of the proposed merger and only one case where the President has blocked the merger (Gardner 1999). The CFIUS needs to take into account specific criteria in considering first whether to hold an investigation and then whether or not there are grounds that the merger might endanger national security. However, some observers point out that while the process may seem innocuous, a complaint to the CFIUS has the potential to impair a foreign investor’s image in the marketplace and thereby adversely affect their plans for the

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proposed M&A (Kang 1997; Liebler and Lass 1995). For this reason many foreign investors in sensitive high technology areas themselves refer their investment to the CFTUS. This means that their strategy is not openly revealed, thereby minimising damage to their prospects of acquiring the target on terms suitable to them. Both Gardner (1999) and Kang (1997) note that most European investors in high technology adopt this approach. While there is no evidence to suggest that the CFIUS uses such self referral as the basis for bargaining with potential foreign investors, Kang and Gardner note the possibility for the CFIUS to use its power for this purpose. Given that 90 per cent of all foreign investment in the US occurred by way of M&A in 1997 - up from a mere 62 per cent in 1992 (The Economist 30 January 1999) - and that this trend is likely to continue (Hatem 1998), the operation of the Exon-Florio process warrants continuing scrutiny. The US action plan submitted to APEC currently contains no proposals concerning the Exon-Florio amendment. Apart from the Exon-Florio amendment, foreign investors are restricted in a number of industries. These include natural resources, air transport, telecom m unications, finance and media. In the natural resources industry, the US limits foreign investment in commercial fishing operations to a minority interest only. In the finance industry, the US Federal Reserve has to be satisfied there is adequate supervision of the foreign investor’s parent bank in its county of origin before an operating licence will be granted. These regulations were amended in 1998 to make it easier for foreign financial institutions to meet Federal Reserve requirements. The Federal Reserve now allows a level of activities that it considers prudent, taking into account the status of supervision of financial institutions in the investor’s home country (Friesen and Nissenbaum 1998). However, there is also a reciprocity test placed on foreign investors intending to invest in the finance sector. In the communications and media industries, foreign investment in radio, broadcasting and common carrier telephone companies is limited to 20 per cent direct foreign ownership and directors of such companies must be US citizens. Air transport, other than freight forwarding and charter operations, is reserved for companies controlled by US citizens, with foreign investment being limited to 25 per cent. For freight forwarding and charter operations there is a reciprocity test. There are also some sectors where state governments can make it difficult for foreign investors to obtain the licences that must be issued by the state government. Some observers note the difficulty experienced by foreign power companies trying to take over US power corporations

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(Rosenberg 1999; Zimmer and Gottlieb 1997). A further example is the limitation that some states place on foreign investment in the insurance industry. In a number of sectors foreign controlled companies are limited in their ability to make use of US subsidy programs. The rationale here is that the US government should not be using US taxpayer funds to support foreign corporations and their foreign shareholders. For this reason, the US imposes a reciprocity test for eligibility in many subsidy programs. The specific programs where foreign investors have to meet stringent regulations to be eligible for assistance include the advanced technology program, the technology reinvestment project, and energy projects. Foreign investors are completely excluded from participating in government subsides provided to agricultural producers. This disadvantages foreign investors in this sector. In terms of performance requirements, the NAFTA agreement gives preference to manufacturers in the three member countries on a number of categories of components. This is an allowable exception under the NBIP, but it does not sit well with East Asian countries that are competitors in these fields. We see then that there are restrictions on foreign investors and circumstances where foreign investment can be blocked in a limited number of sectors. Graham and Krugman (1995: 122) note that the US rates fairly well for equality of treatment of foreign and domestic investors. US policy is also reasonably transparent, with the possible exception of the broad criteria under the Exon-Florio amendment. However in terms of non-discrimination, the reciprocity test is clearly offensive in several sectors to this part of the NBIP. This is particularly the case in the finance sector where the US is pushing others in the region to open their markets. The investment section of the US action plan does not disclose any plans for further liberalisation in any of the restricted areas. Canada As might be expected in view of the NAFTA agreement, the Canadian approach to foreign investment is reasonably similar to the US approach. Most foreign investments in Canada need to be notified only for statistical purposes. However some categories of investment are reviewed before the investor is able to proceed. The categories here are acquisitions of businesses where the assets are greater than $184 million, acquisitions by

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non WTO member countries where the acquisition is greater than $5 million, and acquisitions of business in cultural industries, financial services, transportation and uranium mining. The only category where the establishment of new businesses (greenfield investment) may be deemed by the government to be reviewable is the cultural industries (book publishing and distribution, magazines, newspapers and periodicals, film distribution, sound recording industry and music publishing). Reviews are conducted to ascertain whether the proposed investment is of net benefit to Canada. The criteria that foreign investors must meet for reviewable investments are set out clearly. Since the commencement of the Investment Canada Act in 1984, no proposal has been refused. The policy suggests that Canada welcomes almost all foreign investment if this investment establishes new business. Canada also welcomes take-overs of existing Canadian businesses and reserves the right to review these take-overs only if they involve major firms or are in sensitive sectors. This right is also exercised liberally. Canada also adopts the approach of increasing the amount above which investments are reviewable in line with Canada’s economic growth. The lower threshold that applies to acquisitions by non WTO member countries is puzzling and until all APEC economies are also members of the WTO, this threshold appears to offend the non-discrimination principle contained in the NBIP. Canada’s action plan reveals no proposals for changing its review mechanism. On limitation of foreign ownership and sectoral restrictions, Canada has some limitations in the natural resources and sensitive service sectors. Canada limits foreign participation in commercial fishing to a minority interest. It also requires foreign investors in oil and gas areas to provide a benefit plan to show how the investment will benefit Canada. Only minority foreign participation is permitted in uranium mining. Restrictions in the sensitive service sectors follow US policy closely. In the media industries foreign investment is set at the 20 per cent. As noted above, Canada carefully screens all foreign investment in the media and publishing industries. In air transport, foreign investment is limited to 25 per cent and in local telecommunications carriers the limit is 20 per cent. In the financial services sector, Canada limits ownership in its Schedule 1 banks to 10 per cent by any one person whether domestic or foreign. In other federally regulated banks, foreign ownership limitations have been removed and there are proposals to allow entry of branches of foreign

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banks, rather than only locally incorporated subsidiaries. Canada’s action plan discloses no proposals for further liberalisation. Canada is more forthcoming than the US in the investment guide on the imposition of performance requirements. Canada reserves the right to impose these requirements in accordance with WTO requirements and NAFTA obligations. Australia Australia uses a system similar to Canada’s for foreign investment approval in that only a limited range of FDI needs prior approval by the Foreign Investment Review Board (FIRB). As a result of changes in mid 1999, Australian policy is that only acquisitions of substantial interest in businesses with assets of A$50 million or more, take-overs of offshore companies with Australian assets of A$50 million or more, proposals to establish new businesses over A$10 million and certain categories of investment in real estate need to be notified. Case by case approval is given for new entrants in the media, broadcasting, financial services and telecommunication industries. There are also restrictions in airlines and shipping. The policy of the FIRB is normally not to object to take-overs or the establishment of new businesses whose value is less than A$100 million. Investments over this amount are examined to ensure compliance with the national interest. There are broad criteria for determining compliance, although in real estate there are very specific criteria depending upon whether the investment is in established residential real estate, residential real estate to be constructed, land for residential real estate development, commercial real estate or tourism resorts. Investment in Australian urban real estate is a complex issue and this has long been the most sensitive sector for foreign investment in Australia. Most investment in manufacturing or general services, on the other hand, attracts little government or public attention and as a consequence policies are very liberal. This is despite M&As accounting for a very large percentage of Australia’s foreign investment inflow. Australia has some specific policy guidelines in sensitive service sectors. Following the US lead, the Australian government examines each proposed investment in the financial service sector to ensure that adequate prudential arrangements are in place in the home country of the investing financial institution. Foreign interest in broadcasting is limited to 20 per cent and for newspapers to 30

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per cent. Foreign ownership of the major telecommunications carrier, Telstra, is limited to 35 per cent with new telecommunications companies requiring case by case approval. In the transport sector, a recent change in policy means that foreign investors can acquire up to 100 per cent of domestic airlines. Foreign ownership in Australia’s national carrier, Qantas, is limited to 49 per cent with any foreign airline able to own up to 25 per cent and total foreign airline holdings not to exceed 35 per cent. Australian registered ships must be majority Australian owned. The Australian entry in the investment guide states there are no performance requirements or TRIM. However, as the FIRB has to approve larger investments and as states are consulted, it may be that with some larger projects conditions could be imposed. As with the US and Canada, Australia’s action plan contains no proposals concerning further liberalisation in its foreign investment policy other than the changes made in recent years. New Zealand New Zealand has also significantly liberalised its approval processes in very recent times. The limitations here are very similar to the Australian position in that foreign investment is divided into land and non-land transactions. In the case of non-land transactions, only investments of over NZ$50 million or more need approval from the Overseas Investment Commission (OIC) and then only if a foreign interest greater than 25 per cent is sought. This approval requirement applies to both the establishment of new businesses and acquisitions of existing businesses. The criteria upon which the application is assessed are set out clearly in the OIC web site and include an assessment of the business capabilities of the intended investor, their financial commitment and the character of the people controlling the business. In the case of land transactions, the New Zealand situation is much more straightforward than the complex categorisations in the Australian policy. Other than for islands, for foreshore lands over 0.4 hectares and other land over five hectares or NZ$10 million in value, approval is not necessary. The situation in New Zealand is also more straightforward than in Australia on special requirements for investment in particular sectors. New Zealand has no specific requirements other than those referred to above for investment in finance or in media industries. In the transport sector, New Zealand policy resembles Australian policy on ownership in its national

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airline. In the telecommunications sector too, New Zealand policy is similar to Australian policy, with foreign investment in NZ Telecom limited to 49 per cent. Thus foreign investment policy in New Zealand is very liberal for transactions under NZ$50 million. However conditions can be imposed for larger investments, as in the Australian case. Both New Zealand and Australian policies have scope for giving less than national treatment to foreign investors in large transactions if investment authorities consider it in the national interest to do so. Japan Japan has been traditionally the most restrictive of all of the advanced industrialised nations in approving foreign investment. However formal barriers have been relaxed during the 1990s, with changes most noticeable in the notification system for foreign investment. Japan catégorises proposed investments into those that require prior notification and those that need simply to be notified after the event. It does not distinguish between greenfield investment and investment by way of M&A. Industries can be classified as requiring prior notification if they affect national security, public order or public safety, or if liberalisation is not required under the OECD code of capital movements. Thus there are rather broad grounds upon which industries might be categorised as requiring prior notification. For those industries that require prior notification, relevant ministries are consulted on whether the investment should be allowed and on what conditions. In addition reciprocity requirements are imposed in the finance industry and for land transactions. Most of the industries subject to the prior notification process are in the agriculture, natural resource or sensitive service sectors. They include land transactions, transport, finance, agriculture, mining, energy production and distribution, leather manufacturing, shipbuilding, aircraft manufacture, sporting goods, forestry and fishing. In recent years Japan has removed media and telecommunications from the list of industries requiring prior notification, but heavy restrictions still remain on foreign participation in these industries. In the media industries, foreign ownership is limited to 20 per cent and in air transport the limit is 30 per cent. Investments in the finance industry are approved on a case by case basis and investment in national telecommunication carriers is restricted to 30 per cent.

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Beyond this, Japan does not make explicit the criteria upon which foreign investment will be permitted in those industries subject to prior notification. Much may depend on the view of the relevant government ministry.

The NIEs Here the most significant observation is that the NIEs have liberalised their foreign investment regimes to the extent that restrictions are now almost on par with those of the older industrialised economies. Explanations for this tend to be economy specific. For Singapore and Hong Kong, their small size and consequent dependence on external trade have resulted in a relatively open approach to foreign investment over many decades. For Mexico and Korea, external pressures from the US, the OECD, NAFTA for Mexico and the IMF for Korea have combined to push successive governments in these economies to liberalise their approach to foreign investment. Taiwan remains somewhat behind in terms of liberalising its approval processes as the following section makes clear. However, while the formal entry barriers may appear similar, there may be significant differences in the process of obtaining operating licences. This has major importance because it is quite possible for an economy to appear on the surface to give national treatment to foreign investors but when it comes to the actual process of licensing by various government ministries, restrictions may be imposed. Most business activities require an operating licence of some sort. Investment regulations may create the impression that foreigners and domestic investors are equally entitled to apply for licences but the conditions upon which such licences will be granted, or whether these licences will be granted at all, depends heavily on the local approving body. Thus, while at a surface level it may appear that liberalisation has been achieved, much more comparative, industryspecific research is needed to assess whether liberalisation has extended to the operational level. This issue of level of liberalisation raises important questions around transparency. It is vital for foreign investors to know the criteria for licensing and to have some form of redress if the approving body misapplies these criteria. To take this one step further, we could argue that real liberalisation needs to be assessed in terms of both the licensing procedures in each industry for each economy and the ability of foreign

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investors to successfully challenge licensing authorities if these investors’ applications are refused. With this reservation in mind, the following discussion makes it clear that in terms of formal entry barriers, the NIEs are well along the liberalisation road. There are now few restrictions on the purchase of nonresidential land, in mining and manufacturing and in non-sensitive service sectors. As in the older industrialised economies, most restrictions are in agriculture, fishing or the sensitive service sectors. In the sensitive services sector there have been significant liberalisations since 1994 when investment became a major issue in APEC. In the transport sector, Korea, Taiwan and Mexico have undertaken significant liberalisations in recent years. The newer forms of telecommunications industry are open in most cases to 100 per cent foreign participation. In some economies, power industries are in the process of privatisation, in line with international trends. In the late 1990s the financial sector has been opened up to foreign competition in all of these economies with very few formal barriers remaining. Media industries remain heavily restricted for national security reasons. Other than Taiwan and Mexico, the NIEs do not distinguish between foreign investment by way of greenfield investment or M&A. Taiwan currently limits acquisition of shares by foreigners through the stock exchange to 50 per cent of a company’s share. Mexico requires approval from the National Commission of Foreign Investment (NCFI) for acquisitions above a certain value that result in greater than 49 per cent foreign ownership. Singapore, Hong Kong and Korea claim in their entries in the investment guide that no performance requirements apply. Mexico and Taiwan still have local content requirements in the automotive industries. Mexico is due to phase these out by 2004 and Taiwan states that it will phase these out upon accession to the WTO. Mexico is bound by the NAFTA agreement to give preference to NAFTA member countries on some products and components. In summary, there has been a significant move towards a more liberal investment regime in the NIEs since initiation of the action plan concept in Osaka in 1995. As noted, significant liberalisations have been made in land ownership, transport, telecommunications, finance, the power industry and various other service sectors. In contrast with the older industrialised economies, the NIEs have made specific commitments in their action plans for further liberalisation and specific timetables for achieving this.

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In both the older industrialised and the NIEs, the impact of the APEC process on removing formal entry barriers cannot be dismissed. Various other pressures including NAFTA, the WTO process, privatisation trends and increased international competition for foreign investment have all been instrumental in the liberalisation brought about so far. However we need to recognise that the APEC process provides policymakers in the region with an additional source of pressure to apply to those groups within their own economies who oppose liberalisation on various grounds. As we will consider in Chapter 3, overcoming such resistance can be difficult and complex. Further, as noted earlier, we may need to dig more deeply to ensure that barriers to foreign investment are not in practice being pushed underground in the form of detailed licensing requirements for both foreign and domestic investors. Thus liberalisation needs to be assessed in tandem with deregulation. As I explain later in this chapter, this move can be adequately undertaken only on an industry by industry basis. Singapore Singapore’s policy is to welcome foreign investors on the same terms as local investors. Accordingly there are no special approval requirements for foreign investors and no limitations on the extent of foreign ownership except in a handful of sectors including residential apartment ownership, investment in telecommunications and the media. Investment by foreigners in telecommunications requires that the investor obtain a licence to operate a telecommunication service. The Investment Guidebook does not reveal this, however investment in the finance sector is also subject to licensing requirements and a foreign corporation’s ability to participate depends on the government granting a licence to the foreign corporation. The manufacture of some items including some computer hardware, some steel products, cigarettes and alcohol also requires a special licence from the government. Some observers (Khan 1998) note that it is possible for companies in some industries to have a provision in their articles of association limiting the extent of foreign equity. In effect this means that a special majority of the company’s shareholders must approve foreign investment beyond this specified limit. The message from Singapore is that foreign investors are welcome and only need to go through the ordinary business registration procedures applicable to domestic investors. As such, Singapore’s foreign investment policy, along with that of Hong Kong, is perhaps closest to what is

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envisaged in APEC’s goal of a free and open investment environment. Singapore adheres closely to the national treatment and non-discrimination provisions of the NBIP. However, if foreign investors ask for incentives or seek to invest in one of the few restricted industries categories, the criteria upon which incentives will be given or investment will be allowed are not spelt out in detail in the Investment Guidebook. Other than this, Singapore’s policy also meets transparency requirements. Hong Kong Hong Kong’s foreign investment policy is similar to that of Singapore in terms of formal entry barriers. No special approval is needed for foreign investment other than in the broadcasting and banking sectors. In broadcasting foreign investors are limited to a minority share and in banking conditions are imposed on those wishing to establish either branches or fully licensed banks. The criteria that foreigners must meet are set out clearly in the investment guide. Like those of Singapore, Hong Kong’s investment polices meet APEC’s principles on transparency, non­ discrimination and national treatment to a very high degree. Korea Korea has embarked upon liberalisation of its approval process for foreign investment throughout the 1990s (Bishop 1997, 2001). Under pressure from the IMF, the Kim Dae Jung government enacted a new Foreign Investment Law in 1998 that has made Korea one of the most liberal economies within APEC as far as initial approvals for foreign investment are concerned. Korea requires foreign investors to notify their investment to any one of a number of designated authorities including over 50 banks and the various worldwide offices of the Korea Investment Services Centre (KISC). Some categories of investment need to be notified before the event and others afterwards. The guidebook suggests that the receiving authority will accept notifications promptly except in cases where the foreign investor seeks tax incentives. Notifications can be lodged in English language and investors do not need to appoint a Korean resident to act on their behalf. In response to past criticism over the length of time needed to obtain all of the necessary secondary approvals and licences to start a new business, the government has introduced a comprehensive approval process. This

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enables investors intending to establish new businesses to lodge one application to cover such matters as factory establishment, construction permits, environmental permits and permission to use the relevant materials required for construction. The KISC acts on behalf of the investor in dealing with the various ministries to ensure all such approvals are obtained. If the investor is dissatisfied with the outcome there is an avenue of appeal to the newly established foreign investment ombudsman who has power to solicit information from the various ministries. Korea has therefore attempted to establish a true one-stop shop for all matters related to foreign investment. In doing so it has recognised the need to address not only formal entry barriers but also the main operational restrictions that may sometimes be even more insuperable. This is a remarkable step forward for a country not so long ago described as one of the most closed and as the most difficult place for foreigners to do business in the entire APEC region. Korea has also liberalised significantly its restrictions in various sectors with the effect that Korea almost rates alongside Singapore and Hong Kong in terms of openness. Restrictions apply in agriculture, natural resources and the sensitive service sectors. Fishing, broadcasting, cattle raising and rice and barley production remain completely closed to foreign investment. Sectors where there are limits on foreign equity include telecommunications (33 per cent), wholesaling of meat (less than 50 per cent), cable broadcasting services (33 per cent), air transport services (less than 50 per cent), sea transportation (33 per cent), newspapers (33 per cent) and periodical publishing (25 per cent). Unlike the older industrialised economies, Korea also has in place a specific timetable for either reducing or eliminating some of these limits on foreign equity. Mexico Mexico also began to liberalise its stance on foreign investment in 1989 when it began to relax informally some of the restrictions contained in its old foreign investment law (Calderon, Mortimer and Peres 1995; Houde 1994). It formally enacted a new foreign investment law to coincide with the inauguration of NAFTA in 1993. The new law (as amended) sets up an automatic approval system for almost all foreign investment. This system requires investors only to lodge a notice with the Ministry of Commerce and obtain a permit from the Secretariat of Foreign Relations before embarking upon the other steps to establish a business that is applicable

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to domestic and foreign investors alike. Of some 700 business categories, only 31 require formal approval from the NCFI and 17 are prohibited altogether. Further details of these will be discussed below. Mexico has recently liberalised policies on foreigners’ acquisition of real estate to allow foreigners to purchase non-residential land in the previously restricted zones (100 kilometres from the national border and within 50 kilometres of the coast). This means that for non-residential purchases in Mexico, foreigners are largely subject to the same conditions as those applying to local investors. Residential land is still restricted and Mexican companies that purchase this land need a foreigner’s exclusion clause in their articles of association. Mexico also limits foreign participation in agriculture to a maximum ownership of 49 per cent. Some restrictions apply in the natural resources sector. Fishing is limited to 49 per cent foreign ownership. Mexico’s mining law does not restrict foreign participation but all petroleum activities are reserved to the state. In accordance with this policy there are also restrictions on the manufacture of petroleum products and basic petrochemicals, retail trade in gasoline and liquid petroleum. In the sensitive service sectors, foreign investment is restricted in the electricity generation and distribution industry. It is limited to 49 per cent in both the local and long distance carriers in the telecommunications industry and in broadcasting. Mexico has liberalised its finance sector to the extent that most businesses can be 100 per cent foreign owned. There are still some restrictions on credit unions and development banks. Mexico allows 100 per cent foreign ownership in railway services but requires NCFI approval for proposals involving over 49 per cent foreign ownership of railway operations. Mexico also restricts foreign investment in both passenger and freight land transport to 49 per cent but has signalled that this area will liberalised over the coming few years. Chinese Taipei Foreign investment into Taiwan can be carried out under the Statute for Investment by Foreign Nationals or in accordance with the general company law that applies to domestic investors. Investment that proceeds under the Statute for Investment by Foreign Nationals needs approval by the Investment Commission of the Ministry of Economic Affairs. A number of inducements encourage foreign investors to use this method rather than proceeding via the company law route. Investment under the

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company law requires foreign investors to meet a number of conditions that they may find unacceptable. These conditions originated in the desire of the Taiwanese government to ensure residents’ control over Taiwanese corporations (Liu 1996). Consequently, company law requires that directors and major shareholders of the company be domiciled in Taiwan with board meetings held in Taiwan, a percentage of shares to be set aside for employees, and no preferential rates of withholding tax. These restrictions are waived for investors under the Statute for Investment by Foreign Nationals and accordingly almost all foreign investors proceed in this way and thus need Investment Commission approval. There is no suggestion that approvals are other than readily forthcoming in a short timeframe, but the mere fact of having an approval mechanism gives bureaucrats some discretion over incoming capital and therefore the ability to bargain and impose conditions if they see fit. In terms of sectoral restrictions, Taiwan still has prohibitions or restrictions on many agricultural activities, resource based industries and some manufacturing and general service sectors. In the sensitive service sectors restrictions are comparable with those of the other NIEs. Restricted and prohibited industries are set out in Taiwan’s negative list. Taiwan liberalised real estate acquisitions in 1997 and foreign investors can now purchase land for residences, factories, shops, churches, hospitals and schools. However, approval is still required from both the Ministry of Economic Affairs and the Ministry of the Interior (EAER 15 February 1997). Taiwan does not permit foreign investment in agricultural land or commercial fishing and this investment is restricted in mining. Taiwan’s negative list for foreign investment still contains restrictions on some manufacturing activities including medicines, fertilisers and photographic chemicals. In the general service sector, the construction industry, recreational services, real estate and legal services appear to be the major restricted industries according to the negative list. In the sensitive service sector, investment in utilities (electricity, gas, water) was earlier reserved for the state but privatisation is now under way in line with international trends in this direction (Business America September 1998: 9). In the telecommunications sector, Taiwan has recently allowed foreign investment in its mainline carrier to the limit of 60 per cent. In the newer areas of mobile phone and other cellular network telecommunications, policies are more liberal. Along with Mexico and Korea, Taiwan allows up to 100 per cent foreign participation in mobile phone operation but foreign investors need to win licences for these

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operations. Taiwan approves both foreign and domestic banks and insurance companies on a case by case basis. It restricts foreign investment in railways, sea and air transport and in motor vehicle transport industries other than car rental, freight and container tricking. It also prohibits foreign ownership in broadcasting other than through cable and satellite services, which are restricted. The negative list sets out the relevant ministry that needs to approve any foreign investment in restricted industries. Yet no conditions are disclosed here, leaving the terms upon which foreign investment will be allowed to the discretion of the various ministries.

The Developing Economies The most striking difference between the developing economy group and the newly industrialised and older industrialised economies is that most developing economies still have formal approval processes for foreign investment in most sectors. In most economies this applies whether the investment is a greenfield investment or by way of M&A. The implications are that most foreign investments in these economies are screened by investment agencies in an attempt to ensure net economic benefit from the investment. The advantages of this operating style are m ax im u m opportunity to assess the extent to which the project will contribute to national development goals. The degree to which the governments of economies in this group insist on examining potential benefits depends very much on the governments’ overall approaches to economic development. In some of these economies there are also political reasons for the maintenance of screening mechanisms. Both the economic development considerations and political constraints involved in removing screening in developing economies are discussed in more detail in Chapter 3. A second observation is that the bigger four Southeast Asian countries also operate one-stop shops for investment approval. This serves the dual purpose of enabling agencies to easily monitor and assess foreign investment proposals while at the same time assisting foreign investors to overcome many of the initial operating barriers that they would face in the absence of such facilities. The ability to obtain initial business operating licences through a one-stop facility is a significant incentive to foreign investors as noted above in the case of Korea.

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In terms of sectoral limitations, the most important observation is of a marked difference between the approach of Southeast Asian economies in the group and the two Latin American economies, which have moved more quickly to a more open market position on foreign investment. Both Chile and Peru have constitutional provisions stating that foreign investors are to be given equal treatment with local investors and there are few exceptions to this claim. The Southeast Asian countries tend to take a much more careful approach in limiting foreign investment in agriculture, land ownership, resource based industries and services, in line with their more managed approach to economic development in general. However, two qualifications are needed here. First, extensive privatisation is under way in many of the Southeast Asian countries particularly in the finance, telecommunications, power and transport industries. Second, in line with their policies of encouraging export oriented industrialisation, the Southeast Asian economies have relatively liberal policies on foreign investment in the manufacturing sector. I consider this in greater detail in the discussion below. A related observation is that all members of the developing country group need extensive investment in infrastructure to further their economic development potential. However, rather than adopting the ABAC suggestion to adopt open policies in industries such as power, water, transport and telecommunications, the approach of countries in this group has been more cautious. The approach of Chile and Peru to much of their infrastructure is to manage it under a concession system in which the state grants private companies the right to construct and operate infrastructure. Indonesia encourages foreign investment in large-scale infrastructure by allowing foreign investors up to 95 per cent foreign ownership. In Malaysia and Thailand traditionally, significant state-owned enterprise dominated the infrastructure industries. This dominance continues, but the approach is to increase private participation through the privatisation process and in the case of Thailand with a build-operate-transfer law. The Philippines Constitution limits foreign investment in most infrastructure to 40 per cent. However the Philippines also has a build-operate-transfer law that provides special conditions for foreign investment in some infrastructure projects. A final necessary observation is that in some cases, the descriptions of sectoral restrictions contained in the investment guide lack detail. The investment guide would be much more useful if the approval requirements and limitations of foreign investment were set out sector by sector. To

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obtain further information concerning various sectoral restrictions particularly in the service sectors one must examine other parts of the individual action plans of each economy. The general services section of each action plan is generally much more detailed than the investment section of the action plan on investment in the services sector for these economies. The best example of detailed sectoral restrictions in the investment section of each country’s action plan is that of Chile. Each sector that contains limitations on foreign investment is set out separately with the relevant limitations set out in full along with a reference to the relevant laws that apply. It is difficult to assess performance requirements in these economies, as the information provided is very brief in most cases. There may also be differing interpretations of the term such that some economies have not disclosed what are ordinarily considered performance requirements while other economies have disclosed requirements that are closer to general operating matters than to special performance requirements imposed upon foreign investors. Brunei, Papua New Guinea, Indonesia and Peru claim in their entries in the Investment Guidebook that performance requirements are either limited or not practised. Malaysia and Thailand acknowledge performance requirements are applicable in the form of local content rules but claim that they aim to phase out these requirements. The Philippines lists performance requirements in the automobile sector and in the manufacture of soap and detergent with plans to phase these out during 2000. Chile notes that it requires copper-producing companies to establish a reserve fund to benefit local manufacturing and also that it has a 40 per cent local content requirement in television programming. As we have noted above, there has been ongoing liberalisation of investment regimes in this group of economies since 1995. Peru has enacted a new law to encourage investment and remove some restrictions in the agricultural, mining and telecommunications industries. Papua New Guinea is in the process of reviewing its policy. Malaysia has relaxed its tough policies on equity limits in the manufacturing sector and continues to privatise its telecommunications and energy sectors as well as ports, railways and airports. Indonesia has partially opened the retail, wholesale and trading sectors to foreign investment and has lifted equity limits on investment via the stock exchange. The Philippines has raised the foreign equity limit applicable to investment in finance companies and investment houses. It has also opened the domestic construction industry. Thailand has

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opened the residential real estate market and introduced a new Foreign Business Act, although opinion is divided on whether this law actually increases potential opportunities for foreign investors. I explore this further in the following chapter. In terms of future plans for liberalisation, Indonesia proposes to continue to review its negative list and in particular to look at removal of restrictions in the telecommunications, tourism, international sea transportation, energy and finance sectors. Thailand is working towards removing local content requirements, keeping its negative list under review and aiming to privatise telecommunications, energy and ports. Malaysia is also working towards phasing out its local content requirements. Other than these specific proposals, very little further specific action is proposed in the investment sections of each country’s action plans. Indonesia Indonesia approves all foreign investment whether through greenfield investment or M&A. In 1998, the government simplified the administrative process by allowing the Chairman of Indonesia’s investment agency, the Indonesian Investment Coordinating Board (BKPM), to approve all investment up to $100 million rather than keeping investors waiting on approval from the Indonesian president. The stated time limits for investment approval are now 10 to 20 working days. The BKPM acts as a one-stop shop by granting many of the licences required by foreign investors including import licences, tax holiday facilities and proposals for expatriate personnel. In addition each provincial government has an investment board known as the Regional Investment Coordinating Board (BKPMD). Under the 1998 changes, regional investment boards can approve investment projects up to $10 million as well as issuing the various licences that the BKPM issues. It is proposed to extend the approval authorities of regional investment offices and to allow foreign investors to submit investment proposals directly to the Indonesian embassies in various countries (Investment Experts Group, August 1999). Restrictions on foreign investment extend across all sectors. It is still policy that even where sectors are open to 100 per cent foreign ownership, foreigners must divest at least 1 per cent to Indonesian citizens or business entities within 15 years of beginning operations. The exact percentage that needs to be divested is not specified but will be negotiated at the time of approval of the investment (Homick and Nelson 1998). Foreign investors

References 191

Moran, T. (1998), Foreign Direct Investment and Development, Institute for International Economics, Washington D.C. Moran, T. (1999), ‘Foreign Direct Investment and Development - A Reassessment of the Evidence and Policy Implications’, paper at OECD Conference on the Role o f International Investment in Development, OECD, Paris, 20-21 September. Mortimer, M. (1998), ‘Getting a Lift: Modernizing Industry by way of Latin American Integration Schemes. The Example of Automobiles’, Transnational Corporations, vol. 7, no. 2, pp. 97-136. Norton, P. (1991), ‘A Law of the Future or a Law of the Past-Modem Tribunals and the International Law of Expropriation’, The American Journal o f International Law, vol. 85, pp. 474-505. OECD (1983), Investing in Developing Countries, OECD, Paris. OECD (1993), Promoting Foreign Direct Investment in Developing Countries, OECD, Paris. OECD (1998), Foreign Direct Investment and Economic Development Lessons from Six Emerging Economies, OECD, Paris. OECD (1999), OECD Principles of Good Governance, Directorate for Financial, Fiscal and Enterprise Affairs, OECD, Paris. Ogden, J. (1998), ‘Do’s and Don’ts in Indonesia’, Global Finance, vol. 12, no. 7, p. 4. Pacific Economic Cooperation Council (1999), PECC Principles for Guiding the Development of a Competition - Driven Policy Framework for APEC Economies PECC, Singapore. Pahn, P. (1998), ‘Effective Corporate Governance in Singapore: Another Look’, Singapore Management Review, vol. 20, no. 2, pp. 43-61. Peres-Nunez, W. (1990), Foreign Direct Investment and Industralization in Mexico, OECD, Paris. Pfefferman, G. (1991), ‘Foreign Direct Investment in Developing Countries’ in H. Singer, N. Hatti, and R. Tandon (eds), Foreign Direct Investment, Indus Publishing Company, New Delhi. Philippines Political Monitor (1994), ‘Economic Liberalization Continues’, September, pp. 11-15. Pil, S. (1999), ‘Bringing Korea up to Par’, Korea Newsreview, 22 May, pp. 26-7. Porcano, T. and Price, C. (1996), ‘The Effects of Government Tax and Non-tax Incentives on Foreign Direct Investment’, Multinational Business Review, vol. 4, no. 1, pp. 9-16.

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are not permitted to own land in Indonesia but they may lease land from the state for a period of 30 years. Indonesia reserves most agricultural activities for small-scale industry other than plantations where special approval is required from the relevant ministry. Mining is also restricted with foreign mining companies required to enter into a contract with the state. The oil industry is under the control of Pertamina, a state-owned monopoly. Indonesia reserves most fishery activities to small-scale industries and prohibits foreign investment in the forestry sector altogether. Indonesia’s negative list for foreign investment contains a wide range of manufacturing industries that are reserved for small-scale industries and are therefore closed to foreign participation. These include most basic food and beverage products, basic tools needed in the agricultural industry and traditional Indonesian textile and handicraft industries. Manufacturing activities requiring greater capital investment are contained in the list of activities that require partnership with Indonesian business. These include processing of rice, sugar, rubber, spices and the manufacture of agricultural machinery. For general services, the negative list restricts basic maintenance and repair services, informal trading and most medical services to small-scale businesses, precluding foreign investment in these industries. As in the case of manufacturing, services that require larger amounts of capital such as large-scale retailing, wholesaling, trading and medical clinics (as opposed to basic general practices) require partnerships with local businesses. No indication is given of the level of foreign participation that will be permitted in these industries. In the sensitive services sector, Indonesia is more liberal than in the other categories, seeking to have foreign investors participate in developing infrastructure in power, telecommunications and transport. Indonesia has two major telecommunication companies, Indonesia Telekom and Indosat. Both are being privatised and the government encourages foreign participation to develop the newer telecommunications areas in partnership with these two main corporations. In accordance with its general policy on large-scale infrastructure developments, Indonesia allows foreign ownership of up to 95 per cent in the newer telecommunications industries. The Government is also attempting to increase capacity in the electricity generating industry and is seeking to attract foreign investors into the industry by allowing up to 95 per cent foreign ownership. For the finance sector, foreign investment is permitted in the banking industry but with restrictions on minimum capital,

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geographic location and percentage of foreign ownership. Indonesia is planning to phase out these restrictions. The media sector is closed to foreign investment. Much of the local transport industry in Indonesia is either prohibited for foreign investors or reserved for small-scale operators. However, foreign investment is welcome in major transportation infrastructure projects including rail, road, and air and sea transport with up to 95 per cent foreign ownership allowed. Malaysia Malaysia’s foreign investment regime requires approval for most forms of foreign investment. In the manufacturing sector investors need to obtain a manufacturing licence. In other sectors that are open to foreign investment, most investors need the approval of the Foreign Investment Committee. While the committee is ostensibly responsible only for M&As, its role includes the approval of the acquisition of any substantial fixed assets in Malaysia, the acquisition of any interest in Malaysian companies that gives control to foreigners and the acquisition of 15 per cent of the voting power in a Malaysian company or business by a single investor or 30 per cent by foreign investors in total. These guidelines can readily be interpreted as extending to the control of a newly formed Malaysian subsidiary and possibly even a branch because the term used here is ‘business’. To obtain the necessary approval investors must satisfy the Foreign Investment Committee that the investment will lead to a net economic benefit for Malaysia and will also result in a more balanced Malaysian participation in ownership and control. This latter requirement represents a continuation of the 1970s New Economic Policy (NEP) that sought to give indigenous Malaysians a greater share of Malaysia’s wealth than they then had. Until the early 1970s the ownership of much of the private sector was in the hands of foreign companies or Malaysian Chinese. After serious ethnic tension in the late 1960s, the government adopted the NEP in an attempt to redress the nation’s economic imbalance. The Malaysian Industrial Development Authority (MIDA) effectively acts as the approving body. Like the Indonesian BKPM, MIDA also operates as a one-stop shop and an investment promotion agency. And also like the BKPM, over the years MIDA has gradually extended its authority so that it can grant most Federal level licences such as those required for imports, expatriate posts and the basic manufacturing licence. It also evaluates the eligibility of foreign investors for the vast array of incentives

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that Malaysia offers. MIDA operates efficiently with only a one to two week timeframe for most approvals. Each of the various state governments in Malaysia also operates one-stop centres to deal with the approvals that foreign investors need at the state level, particularly for land use and construction. In terms of sectoral restrictions, Malaysia has a general policy that foreign investors own no more than 30 per cent of any firm. However, exceptions are made to this rule, principally in the manufacturing sector, high technology industries and in some service sectors. The objective of the 30 per cent rule is an attempt to ensure greater ownership by native Malays under the NEP. Malaysia allows foreign ownership of land but approval must be sought from the various state governments whose attitudes towards foreign land ownership can vary. National policy sets out that foreigners are not allowed to own land for speculative purposes. Agricultural activities in Malaysia follow the same guidelines as those for land ownership in general. In the natural resource sector, the oil industry is under the control of Malaysia’s state monopoly, Petronas. The Investment Guidebook discloses no other specific guidelines for investment in this sector. However, the general guidelines regarding foreign ownership and individual state approval requirements need to be borne in mind. In the manufacturing sector, Malaysia relaxed its fairly stringent policy in 1998 to allow 100 per cent foreign ownership in all but a handful of manufacturing industries. This policy is due to remain in force until the end of December 2000. Investment in the services sector is subject to the general approval requirements and policies mentioned earlier. MIDA and the Foreign Investment Committee therefore have considerable discretion on the activities where foreign investment will be permitted and the level of foreign ownership. No specific guidelines are provided in the Investment Guidebook concerning particular sectoral requirements in the services sector. In the sensitive services sector, privatisation is creating opportunities for foreign investors in some areas. Malaysia is undertaking a major privatisation of its major power producer, TNB while at the same time allowing independent power producers to enter the market to boost capacity. There are four major telecommunication companies, with levels of foreign investment ranging from 21 per cent to 52 per cent. New basic telecommunication providers can be up to 61 per cent foreign owned scaling down to 49 per cent within five years of commencing business

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(Burstiner 1998). Thirteen out of the 34 foreign banks operating in Malaysia are foreign owned and there is a substantial foreign presence in eight others. Of 68 insurance companies, 22 are foreign owned. However, new investment in insurance companies is tightly regulated with acquisitions limited to 51 per cent of individual businesses (Bell 1998). In the case of stockbroking firms the limit is 49 per cent (Daneels 1997). Malaysia monitors foreign investment in the media by issuing licences. The Investment Guidebook does not provide details concerning foreign participation in the transport sector. However, in line with general policy all investments in this sector must be approved and the share of foreign ownership must be negotiated if more than 30 per cent is sought. Thailand Thailand has special approval only for foreign investment that falls within the categories covered by the new Foreign Business Act. The Act has three lists of industries attached to it. For industries in List 1 foreign participation must constitute a minority. Those in List 2 can be majority foreign owned if at least 40 per cent is held by companies that are majority Thai owned. Majority foreign ownership of List 2 industries requires specific permission from the Commerce Ministry and an appropriate cabinet resolution. Industries in List 3 can be majority foreign owned if the Department of Commercial Registration and the Foreign Business board give permission. If any of the industries in Lists 2 or 3 are industries being promoted, then majority foreign ownership is allowed in accordance with the conditions of promotion for that particular industry. The three lists contain a wide range of activities in agriculture, general services and sensitive service sectors as I discuss in further detail below. If a proposed business is not on the negative list, then foreign investors need only go through the channels for establishing a business that apply to locals. Thailand allows foreign ownership of land for residential purposes and foreigners can own up to 49 per cent of the units in a condominium. Otherwise land for commercial and industrial purposes is to be leased. Thailand’s new Foreign Business Act reserves most agricultural activities for majority Thai participation and as most are on List 1, majority foreign ownership of these activities is not possible. Likewise, most forestry and fishing activities are on List 1 unless they involve plantation forest or aquaculture. These latter industries are on List 3, making majority foreign ownership possible if the necessary permission is obtained. Mining is on

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List 2 which means that majority foreign ownership is possible with permission from the Commerce Ministry and an appropriate cabinet resolution. It seems likely that only major projects would be able to obtain this permission. The three lists of restricted activities in Thailand’s new Foreign Business Act reveal that the manufacture of traditional Thai products, rice milling and basic building materials must have majority Thai participation unless permission is granted for majority foreign ownership. Similarly, unless permission is granted, Thailand limits foreign investment to minority shares in most professions, construction (other than infrastructure projects), tourism and hotel business, large-scale wholesaling and retailing and domestic trade. Thailand’s power industry remains dominated by state-owned enterprises but there are plans to privatise this industry. Similarly, the telecommunications sector is dominated by two major state-owned enterprises but there are plans for privatisation. Thailand limits foreign investment in road transport to 49 per cent and reserves domestic airline operation to domestic companies. A number of foreign banks operate here and were upgraded in 1997 to full branch status. However, while Thailand has a policy of allowing 100 per cent foreign ownership of banks for the first 10 years of operation, after that time foreign owners are prevented from acquiring any new shares issued for expansion. The objective here appears to be to eventually increase Thai participation in foreign banking operations. The media industry is limited to minority participation. Philippines The Philippines is the most liberal of the bigger ASEAN economies in its system for approving foreign investment. However, there are still a number of sectoral restrictions and in that respect the Philippines is more like its Southeast Asian neighbours than its Latin American cousins. To invest in the Philippines the investor need only establish a company through the Securities Exchange Commission which also registers domestic corporations. The time taken should not exceed 15 days. A special form is required for investments with greater than 40 per cent foreign equity. The Commission will also check whether or not the proposed investment falls into one of the categories on the negative list. In this case, the application to establish a corporation may not be approved.

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To remain competitive with its Southeast Asian neighbours, the Philippines adopted a one-stop approach to investment applications in 1987. The one-stop shop includes representatives from the Central Bank, the Securities Exchange Commission, the immigration department and various other government agencies. Most licences required for operation can be obtained through the services provided. Various export processing zones in the Philippines have the authority to approve investments seeking to establish within these zones. In terms of sectoral restrictions, the Philippines limits foreign ownership of land and agricultural activities to 40 per cent equity. Recent moves to liberalise further were thwarted by deep public opposition. The Philippines limits foreign participation in mining to 40 per cent and in forestry and fishing to minority shares. In the manufacturing sector, removing List C from the negative list in 1996 has significantly opened up this sector. The old List C allowed the government to designate certain industries off limits to foreign investors if it considered there was already enough investment in those industries. The Philippines does not allow foreign investment in retailing or in a range of professional services. Foreign investment is limited to minority participation ranging from 25 per cent to 40 per cent in recruitment agencies, advertising, educational institutions and in the construction and repair of public works. In the sensitive service sectors, foreign investment is limited to 40 per cent in telecommunications, transport, and power generation and distribution and is prohibited altogether in the media industries. In the finance sector, finance companies and investment houses are limited to 60 per cent foreign ownership. Foreign banks are approved on a case by case basis. A limit is kept on the number of new foreign banks, the number of local banks that can be taken over by foreigners, and the number of foreign owned insurance companies. In recent years attempts have been made to remove these onerous restrictions but in many cases this requires an amendment to the constitution (Trinidad 1999). This requirement has proved very difficult to achieve in a democratic setting, as I explain in Chapter 3. At this point we should note attempts to raise the level of foreign equities in finance industries to 100 per cent and to privatise the power generation industries. In the transport sector, the Build-Operate-Transfer Law was introduced in the late 1980s. If the relevant infrastructure is regarded as a public utility, its operation is limited to 40 per cent foreign ownership because of the constitutional restrictions. Privatisation in the telecommunications sector

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has increased opportunities for foreign investors but the Investment Guidebook states that foreign equity is permitted here only up to 40 per cent. Chile Chile has two major mechanisms for the entry of foreign investment. The most widely used is foreign investment under Decree Law (DL) 600. The alternative mechanism is approval by the Central Bank though this does not provide the guarantees that are given in the DL 600 procedure. Foreign investment entering Chile under DL 600 involves the foreign investor entering into a contract with the Chilean State. Chile’s Foreign Investment Committee approves the contract. The timeframe required is 30 to 40 days. The attractiveness of the DL 600 process for foreign investors is that it guarantees the right to transfer capital and profits out of Chile and provides for stabilisation of the legal regime applying at the time of the investment and in terms of tax treatment. The objective here seems to be to provide foreign investors with long-term certainty once their investments are approved. In terms of land ownership Chile is liberal, having limits only on foreign ownership of land within a certain distance from national borders and from the coast. Similarly, there are no specific restrictions on agricultural activities. In the resources sector, the state reserves the right of ownership of all minerals. Foreign investment in the mining industry (other than coal and oil) requires assessment by Chile’s copper commission (COCHILCO) followed by approval from the relevant government department. Nonetheless, there is increasing foreign participation in the industry with Japanese companies in particular having a stake in several large mining concerns. Foreign participation in commercial fishing operations is limited to a minority share. Chile lists no sectoral restrictions in either manufacturing or general service industries. The service section in its individual action plan states specifically that the general service areas of distribution, education, tourism, health, construction, entertainment and advertising have no special restrictions on foreign investors. However, there are of course licensing requirements for the conduct of various professional businesses. As is the case in other developing economies, the energy industry is still dominated to a large extent by state-owned enterprises. However in line with international trends rapid privatisation is under way and has advanced

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further than in the other economies in this group. In 2000 Chile had some 58 power companies, 20 of which were power generating companies, four were transmission companies and the remainder were power distribution companies. The 1998 take-over of Chile’s major power producer, Endesis, by the major Spanish power corporation, Eneresis, highlights the extent to which foreign participation is under way in this industry. In electricity and other areas of public works such as highways, ports, airports, water and gas, Chile has adopted a concession system enabling foreigners to operate the facility for a number of years before ownership reverts to the state (Graff 1996). Chile has completely opened its telecommunications industry with foreign investment allowed in the local, international and mobile phone sectors of the market. The finance sector is fully open to foreign participation and is subject only to the licensing requirements that apply to domestic investors. Seven of Chile’s top 10 insurance companies are foreign owned (Reactions 1997). However, policy on sea and air transport and on the media is slightly more restrictive, with foreign investment limited to minority participation. Peru Peru appears to have the most liberal approval system in this group of countries. The information provided in the investment guide and website suggests that most foreign investment in Peru requires no prior authorisation and that no sectors are completely off limits. The Foreign Investment Law of 1991 offers stability agreements to larger foreign investors and those who are involved in export industries. Foreign investors in Peru must only notify their investment, after it has been made, to the National Commission on Foreign Investment and Technology (CONITE). Nonetheless some limitations exist. Foreign investors are not permitted to acquire land within 50 kilometres of the country’s borders. The law concerning investment in state-owned companies also needs to be consulted given Peru’s previously high level of state-owned enterprises. As Peru privatises, limitations may be imposed on the extent of foreign ownership in some sectors under this law. As is the case in Chile, Peru promotes investment in infrastructure and utilities under a concession system where foreign investors can operate the project for a number of years before ownership reverts to the State. There are also specific licensing and capital requirements for investments in the finance industry.

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Peru appears to be the only member of this group of economies that gives national treatment to foreign investment in mining. Papua New Guinea The Investment Guide states that all business with foreign equity greater than 50 per cent must be approved by Papua New Guinea’s Investment Promotion Authority. Specific approval requirements apply in the mining, forestry and fisheries sector, which represent the major destinations of foreign investment entering the country. In 2000 Papua New Guinea is reviewing its investment policies and notes in its entry in the investment guide that it intends to shift from the case by case approach to approving foreign investment to a ‘simpler system of business registration with ex­ post monitoring of investments’ (Investment Guide 1999: 328). The vast bulk (97 per cent) of Papua New Guinea’s land is held under communal title. While the investment guide indicates that foreigners may be able to obtain land for industrial and manufacturing purposes, smallscale farmers dominate Papua New Guinea’s agricultural sector. Larger scale agricultural projects may be able to obtain approval but there are certain requirements for approval of projects with greater than 49 per cent foreign ownership and the situation regarding land tenure must also be borne in mind. In the mining sector, Papua New Guinea’s has a policy designed to ensure that the interests of all parties are taken into account. All mining projects are subject to a development forum involving land owners, state and provincial governments as well as the national government, in order to arrive at a negotiated outcome on the project. In a similar vein, foreign investors are required to consult with the Papua New Guinea forestry authority concerning investment in this sector. Since Papua New Guinea is in the process of revising its policy, no details concerning investment in manufacturing, general service sectors or the sensitive service sectors appear in the Investment Guidebook. Brunei Brunei’s entry in the Investment Guidebook states that foreign investment is welcome, although most categories need formal approval from this country’s industrial development authority or other relevant ministry.

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In terms of sectoral limitations and ownership restrictions, there is a general policy ruling all investments that use local resources, access the domestic market or involve government facilities must have a minimum of 30 per cent local participation. Export oriented projects may be 100 per cent foreign owned. This policy seems to suggest that all investments in land, agriculture, general services, sensitive service sectors and in domestic market oriented manufacturing require a minimum of 30 per cent foreign ownership. Due to approval requirements, the exact level appears to be subject to negotiation.

The Transition Economies As a result of past policies involving highly centralised economic planning, the transition economies of China, Vietnam and Russia continue to approve all foreign investment. Officials have wide ranging discretion over whether the investment will be approved and, if so, the terms upon which it will be approved. Performance requirements are commonplace across the three economies although China has agreed to begin phasing out some of these upon accession to the WTO. The approval of all foreign investment has both the advantages and disadvantages mentioned earlier - it maximises chances to assess the development potential of investment proposals but also invites the possibility of rent seeking by officials. A major difference between the transition economies and the other developing economies is that several of the developing economies have moved towards implementation of a one-stop shop concept for approval of all aspects of foreign investment projects. This not only assists the investors but it also provides the opportunity for minimising corruption in the approval process. Given the comprehensive nature of the approval process in transition economies, investment authorities are able to either open or close any sector to foreign investors depending upon their perception of the particular merits of the project. The transition economy members of APEC are at a much earlier stage than the other developing economy members in preparing detailed lists of restricted sectors. The information available in the investment guides for Vietnam and the publication on the Russian Khabarovsky Krai region do not give details of restricted sectors. The Vietnam entry does, however, contain a list of sectors that are particularly encouraged. This list suggests a very wide range of sectors are open to investors, subject to the discretion of approval authorities.

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Perhaps because of its longer experience with foreign investors, China moved first to develop a list of industrial activities that are encouraged, those that are restricted and those that are prohibited. The ‘Catalogue for the Guidance of Foreign Investment Industries’ is lengthy. In 2000 the most recent available version promulgated by Ministry of Foreign Trade and Economic Relations (MOFTEC) on 31 December 1997 lists 139 business activities that are encouraged, 111 restricted sectors, and 27 prohibited activities. Careful examination of the list reveals that the Chinese authorities have very definite plans for the sectors in which they want investment and the sectors where they believe there is already enough foreign investment. It is likely that if a proposed project falls in an area to be encouraged, there will be fewer problems obtaining approval. If it falls into a restricted category, there is a much heavier onus on the foreign investor to show that it is to the benefit of China that the investment proceeds. The list reveals that China is trying to attract foreign investment into newer industries and upstream activities rather than the manufacture of end use products. The discussion below of each of the various industry groups in China highlights these points. The action plans of the three transition economies show that all three have taken significant steps in recent years towards a more transparent investment regime. Russia enacted a new Federal law on Foreign Investments in the Russian Federation in 1999. A further law that will set out a specific list of restricted industries is under preparation. Vietnam also enacted a new law in 1996 and has since promulgated a four part list showing industries in which foreign investment is encouraged, activities where foreign investment is subject to conditions, sectors where investment licences will not be granted and geographic areas where investment is especially encouraged. China has already promulgated such a list as discussed in detail above. In terms of the future, the action plans of all three economies show the intention to take a step by step approach to liberalisation. The Vietnam plan indicates that it intends to eventually phase out its approval system and gradually open more sectors to foreign investment. China has also announced a revision to its restricted list and a host of other measures to improve the operating environment. In all three economies foreign investment and domestic investment are still treated separately, often with different laws applicable. National treatment is therefore some way off.

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China Since opening to foreign investment in 1979, China has maintained a formal approval process for all foreign investment proposals. The main approving body is the MOFTEC. Provincial and municipal branches of MOFTEC are able to approve most investment projects. However larger projects still need to be approved by MOFTEC’s head office in Beijing. Rosen (1999) describes the process in some detail. The foreign investor lodges a letter of intent setting out the objectives of the project, which forms a first point of discussion with authorities about the potential investment. Following this, the investor submits to MOFTEC and to the relevant government department in charge of the industry, a formal project proposal that contains an initial feasibility study. At this stage, the project is also formally registered with the appropriate branch of the local people’s government. Following a successful outcome of these processes, the investor then prepares and lodges with MOFTEC both a formal joint venture contract, if relevant, and the articles of association for the proposed company. Once these are approved the investor then obtains a business licence from the State Administration for Industry and Commerce. This licence is then submitted to other government authorities to obtain the other operating permits that the company needs to conduct its business. The Investment Guide suggests that the whole process might take three months. However whether the investment is approved at all and the actual time taken to acquire all of the necessary approvals may vary according to both the nature of the project and its perceived benefit to the region where it is intended to be implemented. The investor can also expect that there may be slight variations by region in the type of documentation required and the order in which documents need to be submitted. There are also differences in the approval processes for joint ventures and wholly owned enterprises. For example, Rosen notes that if the proposed investment is to be in the form a wholly owned enterprise rather than a joint venture, the investor is required to submit a lengthy assessment of the project to the relevant people’s government before applying to MOFTEC. The purpose of this step is to assure the relevant local government that the wholly owned enterprise is able to meet its various obligations under Chinese regulations including such matters as the provision of the basic services and amenities to workers that all workplaces must provide. It is clear therefore that Chinese authorities continue to take a cautious approach to foreign investment and it is the responsibility of the foreign

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investor to satisfy all relevant bodies about the benefits that the project will bring to China. Unlike the investment guide entries of most other developing country entries, the entry for China implicitly sets out the reasons for its fairly stringent approval process by spelling out in some detail the objectives that the government hopes to achieve from foreign investment. These include optimising China’s industrial structure, developing various regions within China, establishing new industries and ensuring that the investment will produce a successful business. I discuss this further in Chapter 3. Land ownership is not possible for foreigners in China. Rather, foreigners are able to acquire land use rights for set periods of time. In the agricultural sector, production of basic food crops, cotton and oil seed are restricted industries. However, the development of new varieties of plants, specialised and new methods of plant production, and new types of fertiliser and pesticides are all encouraged indicating that China wants to attract the latest technologies in the agricultural sector. China’s listing of industries splits mining activities into encouraged areas and restricted areas. While coal and aluminium mining are encouraged, mining for precious metal and non-ferrous metals is restricted. Fishing and logging are also in the restricted categories. An examination of four separate areas of manufacturing industries shows the clear policy goal of attracting manufacturing investment into newer higher technology activities and upstream activities rather than into producing end use products. In the textile industry for example, manufacturing industrial textiles is encouraged but the production of both synthetic and natural fibres used predominantly in the garment industry is restricted. Similarly in the machinery industry, the manufacture of a range of highly specific machinery needed to produce end products is encouraged. However, production of end use products such as automobiles, elevators and electric drills is restricted. In the chemical industry, foreign investment is encouraged in the newer fine chemical product lines and specialised petrochemical products whereas investment in basic refineries, sulphuric acid, minerals processing and the production of raw materials for synthetic fibres is restricted. The electronics industry also highlights China’s intent to move into upstream manufacturing activities. The manufacture of consumer based electronics such as video, televisions and mobile phones is restricted whereas the large-scale production of integrated circuits and electronic spare parts is encouraged.

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Few general service activities are specifically encouraged, despite the desire of many foreign investors to tap the vast Chinese market. Those services listed as encouraged include high-technology construction and maintenance of precision equipment, highlighting a shortage of skills in these areas. The vast bulk of traditional service activities such as domestic and foreign trade, travel agencies, educational and medical services, first class hotels, real estate development and large-scale tourism projects are restricted. We should note, however, that since the list was published in 1997 there has been some relaxation of these restricted areas to allow more foreign investment in the retail and wholesale sectors, travel agencies and foreign trade (Alestron 29 April 1999). There are now at least 19 foreign invested commercial retailing operations in China (Action Plan 1999). In the power industry China encourages investment in power generating facilities other than basic coal fired plants. It prohibits foreign investment in the management of electric distribution networks and in utilities. In telecommunications, specialised equipment manufacture is encouraged but again the management of telecommunications business is prohibited for foreign investors. While management of telecommunications businesses is listed as prohibited, a large number of foreign telecommunications operators do business in China, sometimes controlling telecommunications operations through ingenious multi-media schemes designed to get around the letter of the law. This may be sanctioned by local foreign investment officials but is frowned upon by the central ministries in Beijing (Rothman and Barker 1999). As technology in the telecommunications area is moving so rapidly, it is extremely difficult for regulators in Beijing to keep up with the activities of foreign and domestic investors in individual regions. This is particularly the case where the regional authorities themselves might favour a more liberal approach than the official national line. In the transport sector, China encourages foreign investment in the construction of infrastructure (ports, railways, airport, subways, highways) although it is specified that there should be majority Chinese ownership. However actual transport operations are restricted, including the operation of railways, airlines, cross border transport and taxi services. All activities in the finance sector are listed as restricted. However, this means only that strict conditions are imposed upon foreign investors rather than outright prohibition against them. In 1999 some 178 foreign funded financial institutions operated in China (Action Plan 1999). Approvals have many conditions attached. For example, insurance companies must have a base in the Pudong area of Shanghai before they can be considered for investment

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in other parts of China. The only area of the finance industry that is prohibited is futures trading. The media industry contains a number of areas prohibited to foreign investors including broadcasting, television and films. Publishing and printing are listed as restricted areas. Vietnam Vietnam closely follows the Chinese approach of approving all foreign investment. Approval is given by either the Prime Minister’s department or the Ministry of Planning and Investment depending on the nature of the project. Investments in major infrastructure projects such as power, telecommunications, finance, publishing and broadcasting and in key industrial sectors including cement, chemicals and mining all need the approval of the Prime Minister’s department. The Ministry of Planning and Investment can approve all other projects and delegates this authority to provincial and municipal level authorities if the project is below $5 million ($10 million in the case of the two major cities, Ho Chi Minh and Hanoi). Vietnam also closely follows the Chinese approach to documentation. An intending investor needs to make application and then following a favourable preliminary decision by authorities lodges a business cooperation contract. This gives the details of the investment including the scope of the intended business, its duration, the resources needed, the rights and obligations of the parties and mechanisms for dispute resolution. The investor then files the articles of association of the proposed company for registration. While the new Investment Law of 1996 gives greater freedom to investors in terms of the form of investment, and the type of project, and in partner selection, problems remain with implementing the law at lower levels of the bureaucracy (Evans 1999; Mitchell 1997; EAER 15 November 1997). Chapter 3 discusses in more detail how political opposition from within the bureaucracy can frustrate the implementation of liberalisation strategies. Russia Russia also exercises tight control over foreign investment through a complex approval system. As in China, there are variations by region and by sector of the economy. The basic approval mechanism in Russia is the process of registering the business enterprise. This is necessary to satisfy

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registration authorities and other relevant government departments about the nature and viability of the proposed project. Delays can be lengthy due to the details required by various parts of the bureaucracy and the number of different stages in the approval process. The region of Russia that is linked most closely to the APEC economies is Khabarovsky Krai. This region has its own investment promotion authority that is able to handle approvals for the major sectors of interest to foreign investors - fishing, forestry and mining. The investment promotion authorities have published detailed information about investing in these sectors in the form of a ‘roadmap’ for investors in each sector. These roadmaps are extremely useful for foreign investors intending to propose projects in these sectors as they set out each step of the approval process, all the way through to obtaining the various operating licences. These roadmaps not only state the responsible government departments but in fact go so far as naming the relevant government officials who are responsible for approvals. Most economies in APEC do not go into such detail by sector. As noted earlier, it would be useful to compare such details across APEC member economies in individual sectors in order to gauge the true extent of both formal and operational barriers to foreign investment.

Conclusion The summary section at the commencement of the discussion of each of the four groups of countries considered in this chapter noted that significant liberalisation has been undertaken since investment liberalisation became a firm goal of APEC in 1994. It is worthwhile reiterating these measures. In the developed economy group, Australia and New Zealand undertook reviews of the policy in 1999 resulting in liberalisation in terms of the amount of investment and in some land transactions. Canada and the US have moved to facilitate foreign investment in the finance sector. Japan has recently removed mining and telecommunications from its list of sectors where prior notification is required. In the NIEs, transport and telecommunications sectors have been liberalised in the larger economies in this group. Korea, Hong Kong, Singapore and Mexico are relatively liberal in terms of investment in the finance sectors. In the developing economy group, liberalisation has been uneven. Notable steps include the easing of restrictions in the manufacturing sector in Malaysia, Thailand’s new Foreign Business Act,

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the removal of the old List C in the Philippines, Indonesia’s extensive reforms in 1994 in foreign equity limits and Papua New Guinea’s current revision of its policy. Peru has also introduced a new foreign investment law. Moves towards privatisation have opened up opportunities for foreign investors in many sectors. China has led the way in the transition economies with the publication of a list of encouraged, restricted and prohibited industries as a first step towards a more transparent investment regime. The extent to which APEC processes have contributed to this liberalisation is difficult to assess. There are numerous sources of pressure on member economies to liberalise their foreign investment policies including international competition for FDI, international organisations such as the IMF, the OECD and the WTO, and bilateral pressures. However, the work of the IEG should not be underestimated. At each meeting, one or two countries are required to present their foreign investment policy to all other member economy representatives. This imposes significant pressure on the investment officials who are present to explain and possibly defend aspects of their current policy at least in an indirect sense. It can be argued that peer pressure therefore plays a role, particularly within economies at similar levels of development. However, there is a growing divide between the developed and NIEs on the one hand and the developing and transition economies on the other. This divide is recognised in the APEC process with developed countries required to liberalise their regimes by 2010 and developing economies by 2020. More may need to be done if these targets are to be reached and later chapters explore this issue further. In terms of future plans for liberalisation, the position is a little less encouraging. The developed economies, other than Japan, do not spell out any measures for further liberalisation in the investment sections of their action plans. In the NIEs, Korea, Mexico and Hong Kong have specific timetables for further liberalisation in some sectors. In the developing economies, there are general promises for keeping restrictions under review but as ABAC notes there are few firm proposals. The same can be said of the transition economies. A powerful explanation for some of the unwillingness of countries to be tied to specific timetables for future liberalisation may lie in the economic and political constraints upon liberalisation that I discuss in the next chapter. Some other issues are also a concern. It seems reasonable to suggest that the developed economy group should assume a leadership role in

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terms of investment liberalisation. Yet it has been noted here that in terms of the primary criteria of transparency, national treatment and non­ discrimination, the role of developed countries is slightly disappointing. In terms of national treatment, Australia, New Zealand and Canada still maintain some discretion concerning large investment projects. In the case of Canada and New Zealand, the criteria for assessing projects are set out in some detail but Australia is less transparent than these two, referring only to broad national interest considerations. The larger two economies in the group impose reciprocity requirements in some key sectors, which offends the non-discrimination principle. The developing country group continues to insist on approving almost all foreign investment. While this situation continues, investment authorities have considerable discretion as to the terms upon which an investment will proceed, regardless of whether the sector is open for investment. With approval processes, the Philippines and Peru have moved furtherest away from requiring approval for all investment projects but we must note that when incentives are considered, most investment projects in the Philippines are likely to fall under some scrutiny by the Board of Investment in any event. The same can be said of Thailand and the responses of its national authorities. Developing countries also continue to impose restrictions in most service sectors and in some manufacturing sectors. Here there is a marked contrast between the Southeast Asian economies and the two Latin American economies of Chile and Peru. The Latin American countries’ policies towards foreign investment are far more liberal than their Asian counterparts in terms of sectoral restrictions at the formal entry barrier level, with national treatment enshrined in their investment statutes or constitutions. Southeast Asian countries tend to leave investment in service areas at the discretion of investment authorities. As I note in later chapters, different views about the role of the state in the development process as well as political factors tend to constrain liberalisation initiatives. In Southeast Asia, the state has adopted a more interventionist role and wants to be satisfied about the developmental impact of foreign investment. Thus approval processes and sectoral restrictions both remain in place. Latin American countries have moved more quickly to a less interventionist, free market position. Political factors also tend to constrain liberalisation processes, with the industries that are likely to be harmed by foreign competition often successful in stalling further liberalisation initiatives. In Latin American countries, past authoritarian regimes disregarded

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opposition to their free market policies. This may leave a question mark on their sustainability. However, the more democratic regimes in Chile in recent years have not seen any roll back. This chapter has dealt only with the extent of liberalisation as assessed in terms of formal entry barriers. I have argued that it is possible for countries to appear to be more liberal by removing restrictions at this level, yet to be quite discriminatory when it comes to granting operating licences. This is why Korea has moved to not only address its formal entry barriers but also to adopt a comprehensive approval system for many of the operating licences that foreign investors require. The one-stop shop concept in Southeast Asian countries has similar aims. However, much more research is needed to determine the extent of operational barriers on an industry level between countries. Such research can only proceed sector by sector. Given the need for infrastructure development and finance in most of the developing economy group, these sectors tend to stand out as priorities in such research. This may have been the thinking behind ABAC’S initial proposal concerning liberalisation in infrastructure projects. It may be that there is less entrenched external opposition to liberalisation in these industries because of heavy state involvement in these industries in the past and because of rapid advances in technology in many infrastructure areas, particularly communications. Finally, many of the above reviews of each member country’s foreign investment policy have noted that the country’s entry in the APEC investment guide contains less than full information about restrictions in various sectors. It might therefore be useful for a separate investment guide on formal entry barriers, listing each sector and the restrictions in it at both the formal and operational level. The categories adopted in this chapter could provide a useful starting point.

3 The Constraints to Further Liberalisation Introduction The introductory sections of most of the country chapters in APEC’s Investment Guide suggest that governments view EDI as instrumental in industrialising and developing their economies. Those responsible for framing foreign investment policy are well aware of the potential benefits that foreign investment can bring. These benefits flow from the utility of foreign investment in building internationally competitive firms and industries that will provide employment, generate export income and contribute to the emergence of a technologically advanced modem society with higher standards of living for all. Yet those in developing countries in particular are also aware of potential costs. An influx of highly competitive multinational firms can cause job losses by out-competing local firms and contribute to balance of payments problems through a high propensity to import. In addition, rather than contributing to technological upgrading, the foreign operation might deliberately restrict technology transfer. Governments are therefore not as welcoming to all foreign investment as their policy statements might suggest. The previous chapter has shown that they continue to restrict investment inflows in many sectors and often scrutinise these inflows carefully. Political as well as economic reasons underlie these continuing restrictions. The economic argument for restrictions is couched in terms of the pragmatic need for policies to ensure that the potential benefits from foreign investment outweigh the potential costs. The political reasons revolve around the ability of various interest groups threatened by foreign investment to protect themselves. These interest groups include parts of the business community, elements of the bureaucracy and some politicians. This chapter examines these constraints. It draws a distinction between constraints in the developed countries and NIEs on the one hand and in the developing and transition economies on the other. The first section of the chapter analyses the economic arguments and the national security arguments for restrictions in the first group of countries, concluding that 79

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continuing restrictions are difficult to justify on either grounds. It then assesses the literature on political reasons for restrictions and concludes that for this group of APEC members political factors are inhibiting liberalisation. The chapter then turns to analyse the economic development concerns of developing and transition economies around foreign investment. I argue that there is currently insufficient evidence to claim with certainty that foreign investment will always benefit developing countries. Here I review case studies on the impact of foreign investment in a number of countries, finding no clear consensus and instead a range of views about appropriate policies for these countries as they seek to maximise the benefits from foreign investment. The chapter asks whether, in the light of these differences of opinion about appropriate policy, governments of developing countries should look to the NIEs for examples of how to best utilise foreign investment in the development process. Yet the inconsistency of policy approaches in the NIEs provides little concrete guidance for developing economies in framing foreign investment policies in the current international economic climate. Thus, faced with uncertainty about the economic impact of foreign investment and differing opinions and lessons about appropriate policy responses, the developing countries tend to be cautious in their approach to investment liberalisation. Developing and transition economies also face political constraints to the liberalisation process. These come from business groups, bureaucrats and others who are directly involved in the political process. When these political constraints are added to the economic uncertainties, it becomes clear why the foreign investment liberalisation process is not proceeding as rapidly as some would hope.

Current Constraints on Liberalisation in the Developed and Newly Industrialised Economies The review in Chapter 2 of remaining restrictions in the NIEs and developed economies indicates that most of these economies still maintain some form of screening mechanism for foreign investment and many continue restrictions on foreign participation in the agricultural sector and the sensitive service sectors of media, finance, telecommunications, energy and transport.

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It can be argued that the major beneficial effect of foreign investment in the developed countries is its contribution to building internationally competitive firms domestically through providing a competitive spur to local industry. If this is the case we need to ask why restrictions remain in place. In the following analysis I use the US as the major example to highlight the continuing rationale for these restrictions. Isolated examples can be found to illustrate why restrictions continue in other economies, but detailed analysis is thin. Furthermore, the arguments advanced here concerning continuing restrictions in the US may apply to a considerable extent in the other economies as well, with due regard for differing political environments and variations in the roles of political institutions. Economic Grounds for Restrictions The first question for us to address here is whether there is any justification on economic grounds for governments to continue some restrictions on foreign investment. Graham and Krugman (1995: 67-84) have examined the major economic arguments for limiting foreign investment in the US and argue that none of these arguments has sufficient weight to warrant application of restrictive measures. In response to the claim that foreign investment has a negative effect on the exchange rate due to a relatively high propensity of foreign firms to import, they suggest that while this investment can have some effect on the exchange rate it is no more significant than the impact of a range of other factors. They argue that in 1990 the impact of foreign investment on the exchange rate could have been 2 to 4 per cent but that even in the absence of foreign investment effects, other factors could easily have produced variations of this magnitude in the exchange rate. They argue that criticisms that foreign investment causes job losses are misplaced. Their reasoning is that the major influence on employment in the US is the Federal Reserve’s ability to raise or lower interest rates that in turn influence employment. They claim there is likely to be little or no net effect on employment as a result of foreign investment (Graham and Krugman 1995: 61), and from time to time negative employment effects in some regions and industries are offset by positive effects in other regions and industries. This, of course, can have political implications as I discuss later. The authors also find no validity in the argument that foreign firms keep their high value jobs at home and underpay US workers. They found that to the contrary, foreign firms pay higher wages than do local firms.

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The auto industry was the exception, although the authors make the point here that workers in the US auto industry tend to be highly paid by US standards in any event. They also find no evidence that foreign firms undertake less research and development (R&D) than do local firms. The extent to which firms undertake R&D is influenced more by the type of industry than by the nationality of the firm owner. In response to the strategic trade argument that Japanese firms locate their operations in the US to access the US market internally, the authors find that Japanese firms behave no differently to firms from other investing countries. Again the behaviour of firms links more closely to the type of industry in which they are involved. This finding also diminishes the argument that Japanese firms somehow behave differently to other foreign investors in order to further Japanese trade objectives. The authors did find, however, a slightly higher propensity to import among Japanese firms but suggest that this is due to the relatively shorter timeframe of the Japanese firms’ establishment within the US and the time required to build linkages with local suppliers. Graham and Krugman also examined the ‘fire sale’ argument suggesting that in the late 1980s US assets were sold too cheaply to foreign investors. They concluded that there had been some cost to the US in this regard but that even in the year when this outcome was most significant (1989), the cost amounted to only 0.1 per cent of GDP. In view of the rapid increase in M&A activity in Korea, Mexico, Australia, Canada and Japan, it would be useful to have similar studies examining the effect of sales of assets in these economies to more fully inform our assessment of this issue. Finally, Graham and Krugman examined the argument that foreign firms tend to avoid paying US taxes by engaging in transfer pricing practices. The authors found evidence of this tax avoidance in the consistently lower profits reported by foreign firms compared to local firms in similar industries. The authors argue that the solution to this problem does not lie in further restrictions on investment but in active follow up by tax authorities. If Graham and Krugman’s analysis is accepted and can be shown to hold true for other developed countries in the APEC region, then there can be little justification on economic grounds alone for continuing restrictions on foreign investment other than perhaps to enable assessment of the possible anti-competitive effect that foreign investment may have. In the US, all M&A that meet certain criteria must be reviewed for their possible anti-trust effects. This requirement applies to acquisitions by both foreign

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and domestic corporations. It can be argued that in accordance with US practice there is almost no justification in economic terms for separating foreign take-overs from local take-overs. Thus, screening requirements for foreign investments to monitor foreign acquisitions should not be necessary. Japan and Korea are closer to the US position on this than Australia and Canada. If it is accepted that there is no need to monitor foreign investment for economic reasons, we need to look at other arguments for continuing restrictions in the NIEs and developed economies. National Security Concerns These economies often advance a national security rationale to justify careful supervision of the extent of foreign ownership in agriculture and the sensitive services. The rationale here is national defence: foreign control over industries such as telecommunications, transport, agricultural production, media, energy and finance could reduce a country’s ability to defend itself should the need arise. I noted earlier that national security concerns were the stated reason for introducing a de facto screening mechanism in the US in the form of the Exon-Florio amendment. After investigation, the US President may block foreign investment if it is considered to impair national security. There are differing views on the extent to which national security is a valid ground for foreign investment restrictions. Moran (1998) has advanced the argument that national security reasons for restricting foreign investment need to be more narrowly defined. He suggests that in developed countries, the generally accepted criteria are the possibility of denial, delay, manipulation or the imposition of unacceptable conditions, in relation to the supply of essential goods and services. Moran notes as a general rule of thumb that if more than four suppliers from more than four countries control more than 50 per cent of the market, there are no national security grounds for restrictions on foreign investment. In most cases national security concerns are addressed by a working competition policy. However, Moran suggests that there are several industries where a foreign investment concentration might warrant government intervention. These industries include advanced jet engines, advanced materials, some high speed computer technology, space launch facilities and satellite equipment. It may well be for this reason that US government contracts for

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the supply of defence related equipment have stringent nationality requirements. Graham and Krugman also examine the justification for foreign investment restrictions on national security grounds. They examined the issue broadly and question whether there is a hollowing out of US defence industries through foreign acquisition of US firms in the high technology areas to acquire US technology and transfer it overseas. They argue that counter to the hollowing out argument, the restrictions on defence related contracts might in effect result in the US missing out on the latest technology. This could occur because overseas defence contractors may, in some areas, be more advanced than their US counterparts. They conclude that there is not enough information available to prove either position. In this context we should note that in the one case where foreign investment was blocked under the Exon-Florio amendment, the justification was potential leakage of technology to rogue states (Gardener 1999). It therefore seems that national security considerations may well warrant some restrictions on the activities of foreign firms. However, the current broad ranging restrictions put forward by most of the developed countries in the sensitive service sectors and in agriculture appear to be well outside the relatively narrow justifications for restrictions offered by Moran and Graham and Krugman. If economic and security reasoning can be invalidated, the only remaining reasons for continuing foreign investment restrictions arise from the political constraints that those advocating liberalisation must face. Political Constraints Political constraints on foreign investment liberalisation arise in response to opposition from a number of key sources. One is the existing businesses that perceive they will be negatively affected by the foreign competitors. The others include popular opinion as perceived by legislators and, indeed, the bureaucracy itself. Available evidence on the developed and NIEs suggests that business is far from unified on the issue of liberalising foreign investment. Businesses that believe they will be affected adversely by incoming foreign investment are naturally inclined to oppose it, while businesses that have extensive overseas interests will be reluctant to voice their opposition fearing reprisal from overseas governments against these firms’ interests there (Crystal

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1998). In some cases views may differ even within the same industry depending upon the primary orientation of individual firms. Crystal (1998) has analysed the pattern of lobbying by businesses for governments to restrict foreign investment in the semiconductor, auto and machine tool industries. He argues that the overriding factors determining business reaction to foreign investment are the institutional limitations on the ability of local business to gain results. He argues that businesses in the US have tended not to argue for blanket restrictions on foreign investment per se. Instead businesses attempt to influence politicians to put in place rules of origin, government procurement rules or conditions on subsidies that favour local firms. As I noted in Chapter 2, these are precisely the types of restrictions that the US government continues to apply. The reason for this backdoor approach is that businesses are aware the US government is committed to a broad policy of openness but to preserve their own market position they push government to resort to these other mechanisms. Crystal’s work may be unique in its detailed exploration of business impact on foreign investment policy since there are few studies in this area. Studies using Crystal’s framework could be conducted for other countries in the region to enable useful comparison. These studies could identify areas of resistance to investment liberalisation and, significantly, examine how after first tier barriers are removed some firms exert pressure on governments to establish second tier barriers as has happened in the US. Examining the behaviour of Japanese and Korean firms in light of the recent liberalisation in these countries could provide useful insights. Many complaints by foreign investors about these markets do not concern screening or sectoral restrictions but the underlying barriers in the form of detailed industry regulation that disadvantage foreign firms (The Economist 1 March 1997). It is possible that the sources of such second tier barriers are now not predominantly within the bureaucracy but in businesses pressuring the bureaucracy to keep the restrictive measures in place. Examples from Japan include regulations in the retailing and construction industry (Bremner and Kunii 1999). More significantly for the developed and NIEs is the weight that politicians attach to how liberalisation of foreign investment rules will affect voters and the government’s major supporters. Surveys of voter attitudes to foreign investment in the US show that the public is concerned about foreign ownership for three key reasons. Generally the public perceives that foreign investment lessens US sovereignty, increases US debt levels and does not involve reciprocity, all three of which are

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undesirable outcomes (Mascarenhas and Kujawa 1998). It therefore comes as no surprise that some of the restrictions that the US still imposes on foreign investment are related to obtaining reciprocal treatment for US companies by the home country of the investors. As noted, reciprocity considerations apply to some extent in power, telecommunications, finance and transport investments in the US. Further clear evidence of the willingness of politicians to react to what they perceived to be the public mood on foreign investment is the government’s moves to institutionalise restrictions through formation of the CFIUS and the later enactment of the Exon-Florio amendment. Kang (1997) has argued that formation of the CFIUS was not the result of lobbying by interest groups but because a group of congressmen saw a large inflow of foreign investment into their constituencies particularly from Arab countries and recognised political mileage in being seen to control foreign investment in some way. The Exon-Florio amendment was introduced on the back of a surge in Japanese investment into the US and in particular responding to public grievance at the proposed take-over of Fairchild by Fujitsu. Again congress was persuaded to pass the law because politicians saw mileage in having a mechanism through which they could respond to public concerns over foreign investment and its consequences. The amendment allowed them to refer matters to the CFIUS (Kang 1997). Public opinion is also evident in influencing policy in other countries within this group. In both Australia and New Zealand new political parties have gained some popular support partly from adopting a policy stance advocating a more restrictive approach to foreign investment (Rowe 1998; Corporate Location 1997). This action has not resulted in tightening restrictions in either country, but it may well have made politicians more cautious about the pace of liberalisation. Similarly, the remaining restrictions on investment in Canada’s cultural industries will be difficult to remove given public concerns about loss of cultural identity through the proximity to the US and increasing economic integration between the two economies. Yet it should not be forgotten that politicians also have minds of their own, with their own values and ideas influencing their views on economic policy. A recent US study (Blonigen and Figlio 1998) found that the voting behaviour of legislators with high levels of foreign investment in their constituencies depended on their earlier disposition. The legislators who could be regarded as protectionist tended to become more so if there were

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high levels of foreign investment in their electoral region whereas legislators who leaned in favour of free trade tended to lean more heavily in that direction if they had high levels of FDI in their constituency. Both groups of legislators favoured foreign investment because of the jobs it created in their constituencies. Yet both groups also claimed that it was their policy stance that resulted in increased FDI. Free traders did so on the basis that more investment resulted from free trade. Protectionists claimed that it was tariff and non-tariff barriers that encouraged foreign investors to locate in the US behind these barriers. Thus, each used foreign investment to bolster the views they held earlier. While this study did not directly concern foreign investment policy, it does show that politicians’ attitudes on a certain policy issue can affect related policies and this policy flow on could affect foreign investment policy. From this survey of economic, security and political factors affecting foreign investment liberalisation, it is clear that the impact of political considerations on the pace and extent of liberalisation is the most significant influence in the US, the largest economy in the developed and NIE group. We cannot draw firm conclusions on whether the results of the US studies referred to above are replicated in other countries. However, it seems very likely that for the other economies in this group political constraints would figure largely in reasons for continuing restrictions on foreign investment. This suggests that political constraints require greater attention than hitherto in the research on investment liberalisation.

Economic Development Concerns in the Developing and Transition Economies Despite considerable recent attention by international organisations to the developmental consequences of FDI (UNCTAD 1999a; OECD 1998; Moran 1998; Blomstrom and Kokko 1997). Its impact in terms of establishing a strong and internationally competitive industrial base remains uncertain. The evidence on whether a liberalised investment regime will produce this result is even less certain. Wells (1998) concludes that the state of the evidence is such that policymakers are left to rely on blind faith in order to accept the proposition that a more open foreign investment regime will necessarily lead to better developmental consequences for the national economy.

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Part of the problem in determining the impact of foreign investment on the development of local industry is the absence of data. Lipsey (1992) noted little analysis of the impact of direct investment on the development of local industries beyond case studies. He noted the need for considerable industry-level data differentiating between local and foreign owned firms over a period long enough for local firms to learn from foreign counterparts. In a later study for the World Bank, Blomstrom and Kokko (1997) make the same point. They argue that one of the most important advantages for developing nations are the spinoffs that foreign investment can bring to the host country in terms of learning from the products, production and design processes, management techniques and marketing methods of multinational firms. Nonetheless to properly measure these spinoffs we need to have detailed data for a large number of firms and industries over a long timeframe. In the absence of this data and analysis of it one is left to rely on case studies to make some assessment about the impact of foreign investment on local industry development in these economies. Below I review available case studies. Many deal with the question of local industry development under the more general category of technology transfer because it is, after all, through the acquisition of knowledge about production process, product design and management methods that local firms develop. It will be seen that the case study findings are somewhat contradictory on this important issue. The chapter then proceeds to review the policy approaches that have been advocated in order to maximise the impact. Again it will be seen that there are differences of approach. The end result is that policymakers in the developing economies are left in an uncertain position on how far and how quickly they should liberalise foreign investment restrictions such as screening requirements, ownership and sectoral limitations, and performance requirements. It has to be noted at the outset that while every attempt has been made to locate relevant studies, there is no source that comprehensively identifies these works and some important studies may have been overlooked. The experience here points to a need for establishing a database of studies on the developmental impact of foreign investment in the APEC region and updating it as further studies are produced. In this way policymakers will have a ready source of information to use when making decisions about further liberalisation.

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A Review o f the Evidence for FDl’s Contribution to Building Local Industry: Cross Country Studies This review commences with the work of Blomstrom and Kokko who reviewed the empirical evidence concerning the impact of foreign investment on host countries. Their study emphasised the potential contribution of foreign investment to developing local industry through the medium of technology transfer. Following Lall (1995), they argued that the potential for building local industries could arise in a number of ways. Foreign firms might help suppliers set up production facilities, provide technical assistance, assist in purchasing raw materials, train both their own and their suppliers’ staff or may even help suppliers find additional customers either domestically or in the international marketplace. They note that many case studies show circumstantial evidence of local firms benefiting from multinational corporations (MNCs) by acting as MNC suppliers, utilising the marketing channels of MNCs or by becoming more productive as a result of MNCs. Yet the evidence is far from complete and more research needs to be undertaken to provide a more comprehensive picture of the impact of FDI on host countries. Blomstrom and Kokko noted that apart from the interaction between foreign firms and suppliers, the movement of personnel from foreign firms to local industry is also a major force for developing local industry. But the authors could not draw a firm conclusion on the extent to which this outcome and its development benefits actually occur. Local firms also learn through the demonstration effect with local firms imitating what they observe of the business practices and production methods of their foreign competitors. But again the authors conclude that the few studies available are insufficient to indicate conclusively how important these effects are. Yet another possibility for developing local industry comes from the competitive spur that foreign investors provide. According to this line of thought, local firms are motivated to improve their productivity to compete more effectively with the incoming multinational firms. Again the evidence is inconclusive and the authors also point out the very strong possibility that rather than being able to compete with the incoming firms, local firms will be driven out of business. It should not matter from an economic standpoint whether firms are locally or foreign owned. Yet it is unlikely, except in a very small economy, that foreign firms alone will generate enough economic activity

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to ensure that overall wealth and living standards increase. This is why governments are keen to see foreign firms contributing to the development of local enterprises. Governments fear the political and social consequences of dualistic development in which a small, modem, multinational-dominated sector emerges, benefiting only those few who are connected with it while leaving the vast majority of the country in a continuing state of underdevelopment. Thomsen’s study (1999) conducted under the auspices of the OECD, addresses more specifically the impact of foreign investment in the Southeast Asian region. The major argument advanced by Thomsen is that foreign firms have greater potential to develop local industry if they are domestic-market oriented rather than export oriented. He finds that in Southeast Asia foreign investment is still largely excluded from domestic market operations and suggests that this needs to be changed if the full development potential for foreign investment is to be realised. His study also has direct significance for the question under examination here - the impact on the development of local industry. Thomsen argues that while export oriented foreign investment has propelled export growth in Southeast Asia it has been limited to a small number of products in a small number of sectors and that exports have been produced largely in foreign enclaves with low value added and a correspondingly poor record of technology transfer. Further, he argues that a high propensity to import necessarily leads to weaker linkages with local firms and hence contributes little to local industry development. Thomsen concludes that the record concerning technology transfer in the ASEAN countries is not encouraging. He attributes this to a combination of low absorptive capacity and the enclave nature of foreign investment. As I explore in more detail below, Thomsen recommends, like Kokko and Blomstrom, that the solution to the problems he identifies is to remove barriers to foreign investment in the form of screening requirements and sectoral and ownership limitations. Urata (1995) has examined the extent to which Japanese firms in Southeast Asia have contributed to technology transfer. His study found that while some 70 per cent of Japanese firms transferred lower order technologies such as how to operate and maintain machinery, along with process and quality control, only a few transferred higher order activities such as technology improvements and design capabilities. He therefore concluded that Japanese firms have contributed little to deepen technology development in the Southeast Asian host nations. It follows that their

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contribution to developing local industry is also not significant. Urata attributes this result to a number of factors including the lack of capability of local staff to work with higher order technologies and to the Japanese practice of making manuals explaining higher order technology available only in Japanese language. As to the possibility that local staff might move from their Japanese employers and spread what they have learned from the Japanese company to local firms, he finds that the level of mobility of those local staff in senior management positions is low, thereby limiting the potential for technology transfer. An interesting finding in Urata’s study is contrary to one of Thomsen’s recommendations. Using regression analysis, Urata found that high local participation in equity holdings is shown to promote the transfer of sophisticated technologies since locals are then in a better position to pressure their Japanese partners to transfer technology. Malaysian Case Studies The Malaysian economy has long been exposed to foreign investment. The British dominated much of the natural resource industry and supporting service industries and continued to play a large role in the economy after Malaysia’s independence. In an attempt to distribute wealth and income more widely, the NEP was developed in 1972, requiring that indigenous Malays (bumiputeras) hold a percentage of ownership in all new investment projects. The general rule was that foreign investors could hold only up to a 30 per cent share. During the early 1980s, Malaysia embarked on an export oriented strategy and encouraged foreign firms in export oriented industries (EOI) by allowing these firms to hold levels of equity in export oriented firms directly related to the percentage of the firm’s output that was exported. The question is whether this strategy has assisted the development of local industry. The case studies produce no clear conclusions as the following analysis indicates. Lim and Fong’s 1991 study of foreign investment in Malaysia, Thailand, Taiwan and Singapore provides some useful observations concerning the impact of foreign investment in developing local industry. They reviewed many of the studies on Malaysia to that time. They referred to studies by Lim (1978) who found that foreign investment had created significant employment in manufacturing industries but foreign owned firms made few linkages with local firms, imported most of their inputs and provided little technology transfer. They also referred to a study by

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Hoffman and Tan (1980) who found that foreign investment led to outflows of capital and an increase in disparity of income between regions. They attributed this to the concentration of foreign investment in either resource based projects or import substituting industries. We noted above that around this time the government shifted policy direction using an export oriented growth model as used in the NIEs. The question is whether the EOI model has led to better results in local industry development. Lim and Fong’s findings are somewhat pessimistic in this regard. They found that linkages between foreign owned and local firms in the electronics industry were still poor and attributed this to the enclave nature of foreign investment in that industry as well as the low absorptive capacity of local industry. Low absorptive capacity was exacerbated by both the NEP measures that limited local Chinese participation in new projects, as well as by a lack of investment in local training of engineers. Fong (1992) reviewed a number of case studies concerning technology transfer by Japanese firms to Malaysian counterparts. The range of industries in which the case studies had been conducted included steel, man made fibres, textiles, bridge building, cable and wire manufacture and tableware manufacture. Fong concluded that in most cases only lower level technology was transferred. This was due in part to the Japanese companies’ reluctance to provide locals with the technology that these companies had developed and patented. The author recommended that host country governments need to insist on technology transfer from foreign investors through appropriate policy, and that specific incentives should be adopted to facilitate linkages between foreign and local firms as well as local R&D. Salleh (1995) studied 11 firms in the electronics industry in Malaysia to assess technology transfer. This author’s findings on the role of foreign investment in developing local industry are somewhat pessimistic. Salleh found some evidence of local firms acting as suppliers in the semiconductor industry but in the consumer electronics industry there were disappointing levels of local content. There was no local product design, with most designs originating from parent companies. Most R&D was carried out overseas. While foreign firms trained local staff, much of this was for skills related to process technology. A more disturbing finding was that due to the slow development of local suppliers, foreign suppliers from Taiwan and Singapore had moved into the industry. Salleh suggested that local firms have difficulty meeting international standards or competing on

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price as suppliers partly because of overseas suppliers dumping components. Athukorala and Menon’s (1995) study argues that foreign firms have helped local firms to become exporters by introducing the local firms to marketing channels. However, these authors tend to support Thomsen’s argument that foreign investment is more likely to lead to local firm development in domestic market activities than in export oriented areas because foreign firms tend to source supplies from their own global networks where they can be assured of meeting quality standards. The authors argue that technology transfer was limited in the early stages of Malaysia’s industrialisation but that over time more linkages are being developed. Like many other analysts they conclude that more research needs to be done to establish this conclusively. In this regard, Moran (1999) refers to a study by Rasiah (1995) that showed the increasing sophistication of local firms that supply to foreign electronics firms. Local firms had themselves begun to export, based upon what they had learned from the foreign firms. The edited work by Jomo, Felker and Rasiah (1998) collects a number of studies on industrial technology development in Malaysia and many of the contributors have at least touched upon the role of foreign investment in this development process. The editors suggest that based on these studies it is not possible to conclude whether Malaysia will realise its high technology ambitions if current trends continue. The findings of some of the studies reported in their volume illustrate this point. In his contribution on the electronics industry, Hobday finds that foreign-local linkages are still limited but are growing. Cost is forcing MNCs increasingly to use local suppliers but policies will be needed to ensure that local suppliers can develop their capacity to maintain and deepen their linkages with multinational firms. Rasiah backs up this point by arguing that a combination of appropriate government initiatives and the use of Malaysian managers have helped to develop local linkages with suppliers. On the other hand, Chen argues that in the semiconductor industry Malaysia is still at the labour intensive assembly stage. As yet linkages to domestically owned suppliers and customers are still weak. Similarly Capanelli finds that Japanese firms source low end products from local suppliers and more sophisticated inputs from their established overseas suppliers or from Japanese supply firms that have relocated to Malaysia. However, the study by Leutert and Sudhoff on linkages in the auto industry shows that the failure to establish linkages is apparent not only between

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local and multinational firms. These authors suggest that there has also not been the clustering of domestic suppliers to any of the large automakers (including the Malaysian automaker) that would have been desirable. They say that domestic parts firms remain confined to low technology products and inter-firm subcontracting remains undeveloped. The recent move by the Malaysian government to develop a multi media super corridor is an attempt to upgrade the nation’s overall technological capability. The government is insisting that the companies invited to participate must show a commitment to sharing skills with locals. However, some observers (Johnston 1997) question whether there is a sufficient skill base for this initiative to take off as planned, referring to the past practice of MNCs using Malaysia as a low cost manufacturing base. The multimedia super corridor may well be a useful project where further work can be undertaken to examine the issue of technology transfer and the development of local firms. Indonesian Cases Saad (1995) has drawn attention to the importance of foreign investment as a source of technology for industrial development. The author contends that in Indonesia’s case most of the technology transfer comes from training of staff by foreign firms. However, low absorptive capacity resulting from low levels of education in technical areas and lack of R&D by both government and private companies is a major problem in skill transfer. Counter to the views of some authors discussed above, Saad concludes that export oriented investment might assist in furthering technology transfer. Sjoholm’s comprehensive analysis (1999) examined the impact of foreign investment on local industry by looking at spillovers at an inter and intra industry level and at both the national and regional levels. He used increases in productivity as a measure of spillovers, finding that inter­ industry spillovers were significant at a regional level with increased productivity of local firms resulting from the technical assistance and support provided by foreign firms to local suppliers. However for intra­ industry spillovers, he found that while there were positive effects on productivity at the national level, this did not occur at the regional level. The implication here is that foreign firms were out-competing local firms in the same industry. One conclusion that could be drawn from this important study is that foreign firms are more likely to contribute to the

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development of local support industries but to eliminate local competitors in the same industry. Thus the impact of foreign investment may well be to establish multinational firms as industry leaders with local firms only playing support roles. Repeating Sjoholm’s analysis for other economies would enable us to see if the results of his work in Indonesia are consistent on a cross-country basis. China Cases Sun’s study (1998) of the automobile and electronics industries in China found a significant and increasing element of local content in both industries and by implication foreign firms have made a contribution to the development of local industry. To illustrate, the author notes that in 1987, Volkswagen cars had only 5.7 per cent local content but this level increased to over 89 per cent by 1993. General Motors used about 40 per cent local content in their new production plant in Shanghai at the time of the study. Sun also finds significant local content in production of televisions and elevators but slightly less local content in highly advanced telecommunications equipment manufacturing. The author concludes that his study shows that foreign firms have not remained as enclaves but have integrated with local firms - transferring technology and upgrading skills. Hayter and Han (1998) argue that in Shanghai there has been careful selection of investors and the imposition of conditions to ensure that the technology imported by foreign firms is shared with locals. To assist in this process, Shanghai authorities have brought the best technicians from across China to learn from the multinationals that it has encouraged to locate in Shanghai. On the other hand, Wu’s study (1999) of foreign investment in China’s Special Economic Zones finds that despite some transfer of product and process technology, overall technology transfer has been limited by the relatively small size of investments in these zones. In particular, Wu notes that many of the investments from Hong Kong were simply to shift out production to lower cost centres and the level of technology was relatively low in these firms. This finding is supported by Young and Lan’s (1997) study of foreign investment in Dalian. These authors found that technology transfer depended upon the capability and willingness of investors to transfer the technology and the capability and willingness of local firms to receive it. The authors found that in the relatively low percentage of cases where technology was actually transferred, it was mostly low level and

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more in hardware (operation of machinery) than software (design and process). They also noted evidence of weak linkages through improvements in product quality, transfer of skills and training of local suppliers. Thailand Cases Pupphavesa and Pussarungsri (1995) examined five Thai supplier firms in the electronics industry to determine the levels of technology that they had acquired. The authors defined technology acquisition in terms of knowledge about product, quality control and the process of manufacturing. They found that of the five firms, only three had achieved a ‘middle’ level of knowledge in these areas, defining a ‘middle’ level of knowledge as a good understanding. Only one of the five firms had achieved a ‘higher’ level of knowledge with clear understanding of the design of the product and related processes. In this respect, this study confirms many of the findings that we considered above in relation to Malaysia. The authors also examined the reason for low levels of technology transfer in terms of job mobility. In a survey of 11 foreign firms and 12 local firms the authors found that trained workers tend to remain within the foreign firm or to move between foreign firms which limits the diffusion of knowledge to domestic competitors. This behaviour provides a strong explanation for slow diffusion of technology. The finding is also supported by Lim and Fong’s study of Malaysia, Thailand, Taiwan and Singapore (1991) that noted the limited supply of skilled labour was absorbed mostly by foreign firms and that local firms were left to acquire technology largely through the purchase of equipment. Mardon and Paik (1992) argue there has been limited technology transfer and limited management training by foreign firms in Thailand. The authors attribute this outcome to a high level of foreign ownership in key Thai firms. They suggest that of the ten largest Thai firms, five were 100 per cent Japanese owned and the remaining five were controlled by foreign capital. Tambunlertchai and Ramstetter (1992) also suggest that there have been weak linkages between foreign firms and local industry in Thailand. They argue that this has been due to a lack of information about local suppliers, on the part of foreign firms, the inefficiency of local suppliers and a lack of skilled suppliers. They suggest that these problems will be overcome in time.

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Other authors are more optimistic about the effect of foreign firms on the development of local industry. Jansen (1995) argues that foreign investors have not crowded out local firms. The implication here is that while foreign investors might not have assisted in local industry development, neither have they had a negative effect in e lim inating local business. UNCTAD (1999a) also find that there is positive evidence of crowding in in the Thai case. Doner and Ramsay (1993) also claim that entrepreneurship is not weak in Thailand since a fragmented power structure puts local firms at an advantage in extracting support for local business from the state. Moran (1999) notes that in the auto industry, Japanese investment led to the rapid development of a local supplier industry. He notes that of the 150 firms that qualified as parts suppliers, only one half had some level of Japanese ownership and the remainder were fully Thai owned. The review and discussion above presents a mixed picture of the extent to which foreign firms actually assist in developing a vibrant local supply industry. However the outcome is important for developing countries and for foreign investment liberalisation. The more extensive the collection of comprehensive studies on the impact of foreign investment on technology deepening in the host country, the better informed will be policymakers who determine the pace, nature and extent of foreign investment policy liberalisation. Reasons for Poor Performance of the FDl in Developing Local Industries At the start of this section I noted that a major hope of policymakers in developing economies is that foreign investment will lead to the development of vibrant, internationally competitive local firms. The evidence reviewed above suggests that this contribution is yet to result. There is significant evidence that foreign investment has contributed to export growth and employment in the host country (Thomsen 1999), but the record in terms of developing local industry is far less satisfactory. As we have seen in the analysis here, two main explanations emerge for this disappointing result. One is that in developing economies local firms lack the necessary capabilities to learn from their foreign counterparts. A detailed study by Borensztein et al. (1998) of 69 developing countries over two decades found that developing countries need to have a certain basic level of skills before the benefits from foreign investment will become apparent. In particular these authors found that it is only when the host

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country has a certain level of human capital development that foreign investment will be more productive than domestic investment and therefore contribute to economic growth. Borensztein et al. used average years of secondary schooling as the measure for human capital development. They found a threshold level of half a year of secondary schooling is necessary to ensure that foreign investment is of benefit to host nations. This could explain some of the disappointing results from the case studies mentioned earlier. For example, Hart-Ladsberg and Burkett (1998) note that 72 per cent of Thailand’s labour force have only a primary school level of education. Other observers also recognise the low capability of local firms as the reason for the disappointing results in host countries absorbing technology (Thomsen 1999; Lim and Fong 1991; Saad 1995). Some attribute this more specifically to low levels of investment in training locals in engineering and associated skills (Lim and Fong 1991; Lall 1996), which if upgraded would increase local capability to absorb the technical details of production processes and encourage movement towards local design efforts. Other analysts point to the limitation on export growth that results from low absorptive capacity. Dowling (1996) argues that further export growth will depend upon an economy’s transition to higher value added and more skill intensive industries. This requires increasing the population’s general skill level. Dowling notes that in the Southeast Asian economies there are still human capital constraints to the development process despite rising expenditures on education and training. Johnson (1997) argues that unless these constraints are addressed then foreign investors will stay away, finding it too expensive to bring all of their trained staff with them. In Malaysia’s case, Klinghoffer (1998) suggests that requirements for certain levels of participation by bumiputera deter foreign investors because of the difficulty that foreign investors have in finding adequate numbers of skilled people in this sector of society. Yet transfer of technology also depends upon the capabilities of foreign investors to diffuse knowledge widely. The emphasis on export oriented foreign investment in Southeast Asian countries has been accompanied by the location of foreign investors in enclave-like zones. But as the OECD (1998) notes, export enclaves may work against the diffusion of technology and establishment of linkages with local firms, especially if foreign investors are located in a separate customs territory. Lim and Fong (1991) and Lall (1995) attribute part of the problem of poor linkages with local

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firms in Malaysia to the location of foreign firms in free trade zones. Policymakers are therefore faced with difficult decisions concerning export oriented foreign investment. To attract this investment in the first place the host country needs to provide adequate infrastructure and free trade zones provide a quick solution to this. Nevertheless, the evidence of poor linkages must lead policymakers to question this solution. As Athukorala and Menon (1995) note, the resolution of the dilemma may occur only as economies become more developed industrially and foreign firms need to rely less on the superior infrastructure in the free trade zones. They argue, as does Lall (1995), that this is now beginning to occur in Malaysia. In addition to having the capability, local entrepreneurs also need to be willing to benefit from the technology that is on offer in the foreign firms (Young and Lan 1997; Clarke and Chan 1995). Young and Lan’s study of foreign investment and technology transfer in Dalian in China found that the primary motivation for more than one third of local firms entering into arrangements with foreign investors was to take advantage of the favourable tax advantages that the government offered while a further quarter simply wanted the capital that the foreign investor was able to supply rather than the skills. It has also been suggested that Malaysia’s preferential policy towards bumiputeras has resulted in little incentive on the part of local Malays to learn from foreign firms as opportunities for making profit do not require significant effort on their part (Alavi 1998; Chen 1992). The Economist (24 June 1995) goes further suggesting that in all Southeast Asian countries crony capitalism stifles the entrepreneurial initiative of those who are not in the state’s favoured group. Thus many businesses do not pursue the opportunity of entering into joint ventures and other relationships with foreign firms from which they might learn. The Policy Response I argued in the preceding chapter that the developing economies of APEC continue to restrict foreign investment through screening processes, sectoral and ownership limitations, and performance requirements. The question for policymakers is whether removing these restrictions is the best pathway to developing a vibrant, internationally competitive private sector. Unfortunately policymakers find little agreement on the best policy approach. On the one hand, a large number of authors suggest that it is necessary to maintain these particular restrictions in order to ensure that local linkages are formed, that foreign business does not crowd out local

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business and that there is pressure on foreign investors to contribute to the learning efforts of local firms. On the other hand, some authors suggest that restrictions deter the type and volume of foreign investment that developing countries need in order to make the transition to developed country status. Faced with conflicting opinion from experts, policymakers have difficulty in choosing the appropriate mix of policies. This issue is vitally important to the future pace and nature of investment liberalisation within the developing country group of APEC members, so the arguments both for and against policy liberalisation need to be explored in greater detail to inform development of the policies most appropriate for each nation’s needs and preferences. The UNCTAD review of foreign investment and development (1999a) seems to lean in favour of maintaining some form of restrictions in order that developing economies obtain the best developmental results from foreign investment. The reviewers point to the need for developing countries to target specific types of investment to maximise the chances that local firms will be crowded in. The report mentions examples from Thailand and Mexico to suggest that importing foreign investment with high technology to an underdeveloped sector in the host state might not be as effective as restricting entry to promote local capabilities (UNCTAD 1999a: 214). The report also suggests that in Malaysia and Singapore the linkages that have occurred have been as a result of policies to upgrade the skills of local firms and carefully select the right kind of investor (UNCTAD 1999a: 237). This implies the maintenance of some form of screening process. The UNCTAD report also suggests that the infant industry argument for protection against competition from more competitive internationalised firms might be justified in the interests of developing local linkages and technological deepening. But with this comes the proviso that the industries must only be sheltered for a strictly limited period of time if they are to mature and that the social benefits of such protection outweigh the social costs (UNCTAD 1999a: 319-22). This implies some sectoral restrictions on foreign investment. Further, the authors argue, government policies such as local content and pressure on foreign investors to transfer technology may be beneficial provided they are part of a wider strategy for upgrading local capabilities. This suggests a continuing role for joint ventures and performance requirements. Most significant in the report is the assessment that ‘a laissez faire approach is unlikely to be sufficient given deficiencies in markets and institutions’ (UNCTAD 1999a: 325).

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The conclusions of many of the country specific case studies on the impact of foreign investment tend to support the UNCTAD view. Sun (1998) suggests that an appropriate industry policy is essential for developing countries to get the best out of foreign investment. He claims; it is necessary to identify industries with high linkage potential and to promote foreign investment in those industries. He adds that useful policy tools include joint venture requirements, local content rules and appropriate tax and tariff rates. His book argues that the benefits from foreign investment that he identified for China arose as a result of such government policies. In the case of Malaysia, Salleh’s study (1995) of the electronics industry points out that the lack of Malaysian equity may have been a factor in the poor performance of foreign firms establishing local linkages. After reviewing several case studies, Fong’s (1992) conclusion is that there needs to be government policies that insist on technology transfer. Both Lim and Fong (1991) and Doner and Ramsay (1993) argue that Thailand’s joint venture policy may have played a major role in strengthening local firms. In his study of Japanese investment in Southeast Asia, Urata (1996) found that high local participation in equity promoted the transfer of more advanced technologies since in joint venture arrangements local management can pressure their foreign investor partners to achieve this. Lall (1995) also argues that in a liberalised investment environment, linkages with local firms may be fewer than in a more restricted environment. Lall points to the example of Chile where he says two decades of liberalisation did not produce as impressive developmental results as in the Asian NIEs where more interventionist policies were implemented. On the other hand, a significant body of opinion argues against maintaining restrictive policies on foreign investment. Moran (1998, 1999) argues against local content, technology transfer and joint venture requirements. He claims that local content requirements restrict foreign investors from obtaining inputs at the most competitive prices and of the highest quality, as well as protecting local inefficient firms, and may therefore retard the development of local industry. He suggests that, for example, local content requirements in the auto industry may lead to prices one and a half to two times higher than they would have been otherwise. He suggests that by comparison with no restrictions on foreign investment, technology transfer and joint venture requirements encourage foreign investors to use lower levels of technology, the speed of technology

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upgrading is slower and there is less training of local firms. Moran argues that to capture the most benefits from foreign investment, host countries should abandon their local content and joint venture rules and performance requirements. Foreign firms that locate in their countries are then more likely to tie local affiliates into global sourcing networks. This requires foreign firms to transfer the latest technology to those affiliates as well as the latest in management and marketing skills. Moran tends to assume that these skills will automatically be transferred to local firms but nonetheless provides several case examples from Mexico, Thailand and Malaysia to argue that this has occurred. The OECD review of foreign investment in six emerging economies (1998) also argues that policies designed to enforce technology deepening may have had the opposite effect because such policies encourage foreign investors to bring in lower levels of technology. Thomsen (1999) argues that the restrictive policies towards foreign investment in the four larger ASEAN countries, while designed to develop indigenous capabilities, may have had the opposite effect. He argues that restrictive policies towards investment in domestic-market oriented activities where the potential for linkages is higher, discourage foreign firms from investing. Thomsen refers to studies that indicate a half hearted attitude by foreign firms that are forced into joint venture arrangements. Blomstrom and Kokko’s study for the World Bank suggests that a more competitive environment for foreign investors will lead to better results in technological deepening than a more restrictive approach. A common thread in the arguments of those advocating greater liberalisation to enhance local industry development seems to be that the risk of government failure is higher than the risk of market failure. In other words it is likely that rent seeking pressures on governments will result in misapplication of policies designed to build up local industry. This is because joint venture policies, local content rules and sectoral restrictions lead to governments protecting their supporters rather than encouraging deserving firms that may be able to take advantage of these restrictions to become competitive. A liberalised foreign investment regime not only reduces rent-seeking opportunities but also allows the market to decide the type and sectoral composition of foreign investment. There is a tendency to assume that diffusion of skills and formation of local linkages will be a natural process provided that the skill level of the population is raised to a certain standard through general educational policies. Moran also notes

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that developed countries might set an example for more liberalised policies if they relied less on antidumping laws as protective devices. However, governments may also be swayed in their policy approaches if it can be demonstrated to them that others have adopted a particular policy mix successfully. The developing economies of East Asia look particularly to the experiences of the NIEs for guidance. Do the experiences of the NIEs hold any lessons for these developing economies in designing foreign investment policy? Policy Lessons from the NIEs As NIEs, Singapore, Taiwan, Korea, Mexico and Hong Kong have all succeeded in achieving near industrialised country status over the relatively short period of three or four decades. Yet the approach that each adopted towards foreign investment as part of this transformation differs markedly. In this section we review these differing strategies and assess their lessons for developing countries that seek to implement appropriate policy measures to use foreign investment to build dynamic and internationally competitive local firms. Since its separation from Malaysia in 1965, Singapore has actively pursued a strategy of seeking extensive participation by selected MNCs in its economy. The architect of this policy, Lee Kwan Yew, has acknowledged this deliberate strategy of using MNCs for economic development. Lee Kwan Yew aimed to build Singapore into a first world base in a third world region (Kraar 1997). In doing so, Lee enjoyed first mover advantages in Southeast Asia as far as foreign investment was concerned, and as Fong (1995) notes, few countries have been as successful in attracting high quality foreign investment. Singapore moved through carefully considered stages in the type of MNC that it sought to attract. To establish an industrial base Singapore first sought foreign investment in the basic industries of petroleum refining, metals and food and beverages. Building on this base Singapore then sought out labour intensive exporters and shipbuilding in the 1970s. In 1979, having exhausted its potential as a low cost manufacturing base, Singapore sought to have existing corporations upgrade their production and attracted new investment in such fields as computers, industrial electronics, high value added petroleum products and industrial machinery (Lim and Fong 1991). Since the early 1990s, Singapore has sought to continue attracting MNCs in the high value added petroleum and chemical industries and also in

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knowledge intensive industries. Through a program of privatising previously state-owned enterprises, the government also allowed higher levels of foreign participation in finance and telecommunications to ensure the continuing competitiveness of its service industries (Clifford, Shari and Einhom 1998). Thus, Singapore embarked on a deliberate strategy of using foreign investment to drive its economy. The modem efficient economy that Singapore is today is testament to the success of this strategy. However, there are some elements of caution for developing countries in adopting this approach. There is a significant body of opinion that the cost of this strategy has been some dualism in Singapore’s economic development with those connected to MNCs or government owned enterprises being major beneficiaries and those who are outside this circle being the losers. Lee (1997) argues that the capital intensive, high technology and export oriented sectors of the economy are all dominated by foreign firms. Further, Lee, as well as Lim and Fong (1991), argue that there are limited linkages between this sector and the smaller local firms in the electronics sector. Evidence suggests that some employees have moved on to establish their own businesses as suppliers (Fong 1995), but Lee (1997) finds that only 25 per cent of inputs for large firms are produced domestically. Shimada (1996) explains this by arguing that local firms have been left behind in their ability to supply the high technology inputs needed by the foreign owned sector. Shimada is also unable to find measurable spillovers to local firms in his study of productivity and recommends that policymakers pay more attention to the spillover effects of foreign investment when selecting multinational companies. As noted earlier, the ability of local firms to link into the foreign sector depends significantly on their absorptive capacity in terms of skill levels. Yet Lee (1997) and Lim and Fong (1991) suggest that small local firms are deprived of high quality labour that tends to gravitate to the better paid multinational and government sectors, and that government policy tends to discriminate against local firms that are unable to take advantage of the packages of incentives available to larger firms. Fong (1995) suggests there has been little development of a local entrepreneurial class, unlike the case of Taiwan and Hong Kong. The Singapore experience tends to suggest that reliance on foreign investment as the main driver for economic development may not necessarily succeed in building dynamic, internationally competitive local companies. Some may argue that in a small economy such as Singapore

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this is not of great significance as the foreign and government owned sectors are able to compensate for the relative underdevelopment of local firms. However, in a larger economy it could be difficult to attract sufficient foreign investment to achieve this result. Taiwan has many similarities with Singapore in terms of its island economy status, its resource level, dependence on trade and ethnic Chinese population base (Huang 1989). Taiwan has adopted a staged development strategy similar to that of Singapore by first seeking to establish basic industries and labour intensive exports and then moving through a phase of heavy industry industrialisation followed by a move towards high technology industries. The timing of Taiwan’s shift to attract more high technology industries paralleled this development in Singapore in 1979 and was marked by Taiwan’s establishment of the hugely successful Hsinchu Science Park project. In a pattern similar to Singapore’s, a large section of the economy remained the domain of state-owned enterprises. This was particularly prevalent in the case of service industries. However, Taiwan’s initial approach to foreign investment could hardly have been more different from Singapore’s. Rather than setting out on a path to invite in foreign corporations as the drivers of its economy, the Taiwanese government sought to build up the strength of its local firms first, using foreign investment to do this. In the 1960s Taiwan took a restrictive approach to foreign investment, using it primarily as a means to boost exports. In the late 1960s, it pioneered the use of export processing zones to attract the multinational exporting companies from which local companies could learn manufacturing techniques and international marketing skills. The use of screening requirements to obtain the preferred foreign investment approved (FIA) status allowed the government to carefully monitor the type of investment that was allowed in and the terms upon which this investment entered. It was not until the late 1980s that Taiwan signalled a change in its investment policy, to a more open approach allowing, in principle, investment in all sectors of the economy other than those on a negative list. Further evidence of this change in approach was the abolition of the old Statute for Encouragement of Investment and replacing it with the aptly named Statue for Upgrading of Industries. Under the new regime, Taiwan has not only restricted its relatively generous investment incentive provisions to a carefully selected group of 10 core emerging industries but has also begun to reduce its negative list to allow more foreign investment into the service sectors, including the key sectors of telecommunications and finance. However,

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unlike Singapore, this strategy was more than an attempt to enhance international competitiveness. It was also very much the result of Taiwan’s preparation for joining the WTO and its attempt to establish Taiwan as an Asia Pacific Regional Operations Centre. The latter strategy, embarked upon in 1995, aims to utilise Taiwan’s geographic location and industrialised status to make Taiwan a regional base for high technology manufacturing, sea and air transport, finance, telecommunications and media. What evidence is there that the restrictive policies that Taiwan adopted towards foreign investment contributed to the development of local firms? A number of commentators suggest that high levels of government intervention in relation to foreign investment have resulted in positive outcomes for the development of local industry. Detailed analysis by both van Hoessel (1995) and APEC (1997) of the development of the high technology industries in Taiwan agrees that government efforts were crucial in ensuring that local firms actually benefited from the technology of foreign investors. In particular, nurturing local firms’ capabilities through establishing research institutes, carefully selecting foreign firms that would be invited to establish operations and then pressuring those firms to transfer technology ensured that indigenous capability would develop. Those in senior policy positions appeared to believe that without significant government efforts, foreign investment alone would be unlikely to develop a vibrant indigenous technological capacity. A study undertaken by Chuang and Lin (1999) appears to some support this view. The authors found that foreign firms in Taiwan have tended to import technology rather than undertake their own R&D. Their study found that foreign investment can act as a substitute for R&D in local firms in the sense that local firms prefer to learn what they can from the foreign firms without going to the expense of establishing their own R&D facilities. If this finding is consistent across countries, the implications are that some government action is needed to encourage local firms to do more than merely imitate production methods of foreign firms in order to develop an indigenous capability in the high technology area. The authors of APEC’s (1997) study on the effect of foreign investment liberalisation noted that foreign firms were not keen to establish semiconductor fabrication plants in Taiwan until they could be sure that local Taiwanese firms would pose a major threat as competitors. After establishing this, foreign firms then entered into strategic alliances with local firms for joint development of

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technology. Some have suggested that in both Taiwan and Korea had the government relied exclusively on foreign invested firms without taking action to develop local capabilities, it is unlikely there would be the development of the indigenous technological capability that currently exists (UNCTAD 1999a). Korea has also followed the model of economic development used by Taiwan and Singapore. Yet some clear features distinguish the Korean approach. The most notable of these is Korea’s strategy of supporting the development of industrial conglomerates (chaebol) as the engines of the national economy along Japanese lines. At around the same time as Taiwan, Korea also established export processing zones to boost its export drive in labour intensive products. However at the same time, Korea also sought to actively develop basic industries such as petroleum, metals and chemicals. Unlike Taiwan where these were mostly state-owned, and Singapore where these were mostly foreign owned, Korea adopted a mixed approach with some state ownership but predominately private ownership, usually by the chaebols. In the 1970s, Korea embarked on a heavy and chemical industry drive (HCI) where the chaebols were coerced into establishing several key industries: steel, shipbuilding, heavy machinery, chemicals and metals. The economic downturn that Korea suffered as a result of over-investment in these industries caused some policy confusion in the early 1980s and it was not until the mid to late 1980s that Korea realised that it was behind its competitors in the new knowledge intensive industries. The government’s attempts to have industrial conglomerates upgrade the industrial base of the economy did not gather much momentum until the late 1980s after Korea lost the short spurt of competitiveness in heavy manufactures it had gained as a result of the ‘three lows’ in the mid 1980s - low oil prices, a low exchange rate of the Korean won to the Japanese yen and low interest rates. Korea initially used foreign investment in labour-intensive, EOIs and in building up its domestic industrial base, only when it could not obtain the technology in any other way (Bishop 1997). It was not until the early 1990s that Korea abandoned remaining restrictions on foreign investment in the manufacturing sector and embarked seriously on an overall liberalisation of its foreign investment regime to allow foreign investment into the service industries. These industries were opened on a gradual basis throughout the 1990s not only to increase their competitiveness but also in response to considerable pressure from the US, Korea’s accession to the OECD and the intervention of the IMF after the 1997 financial crisis. Like Taiwan and

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Singapore, Korea relies primarily on investment incentives in its attempt to attract high technology investment. However as I discuss in Chapter 4, the wisdom of this strategy is open to some doubt. Are developing countries able to draw policy lessons from Korea’s approach? Like Taiwan, Korea has embarked upon a deliberate strategy of using foreign investment to develop indigenous industry. But foreign investment was not a principal instrument for this task; indeed it was a last resort. Policy preference was for loan capital over foreign investment, and technology was acquired primarily through licensing, reverse engineering and sending technicians abroad for training, rather than through foreign investment. It was only when technology could not be acquired other than by the presence of foreign firms in Korea that foreign investment was sought. For example, the government found in the 1970s that acquiring technology in the petroleum and chemical industries required the presence of foreign investors. However, in steel production and to a large extent in electronics, local firms were able to access technology in other ways, obviating the need for significant foreign presence in these industries. Studies have shown that foreign investment played a minor role in the Korea’s acquisition of technology. A detailed analysis by the Korean Ministry of Finance on the impact of foreign investment in Korea (MOF 1993) found that the technology acquired via foreign investment was predominantly in the production, process and maintenance areas while in higher order activities such as design and the development of parts and materials, indigenous efforts were more significant. Further, in their study of the development of Korea’s computer industry, Kim Lee and Lee (1987) found that local firms dominated the higher valued added subsectors of this industry. Hong (1994) refers to a survey of Korean business that showed foreign investment came a long way behind licensing agreements, sending technicians abroad, local training, technology and capital imports as a source of new technology. However, it has been recognised that foreign investment plays a major role in stimulating local firms to engage in R&D if more technologically advanced competitors enter the marketplace (Byun and Wang 1994). For this competitive spur to be effective, local firms need the capacity to undertake their own R&D and government is seen to have a key role in ensuring that local firms have this capacity. Since the 1960s the Korean government has continued to take a lead role in establishing research institutes and providing training. At first glance, it might be assumed that developing countries should emulate the Taiwanese and Korean approaches of carefully monitoring

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foreign investment to ensure that local firms learn from it and develop indigenous capability. However, for a Korea/Taiwan type strategy to be effective, it requires not only significant capacity to intervene on the part of government agencies but also the willingness of local firms to go along with government plans. These requirements are bound up inextricably with the capacity of government to run an effective industry policy. I have argued elsewhere (Bishop forthcoming) that both the current international economic climate and domestic political constraints make a well ordered industry policy more difficult to implement in the Southeast Asian nations than in the earlier developers in Northeast Asia. For that reason, while the Taiwan and Korean model might look attractive, some of their features are idiosyncratic. This means that attempts by other governments to emulate the model might prove less effective than in those two economies. Mexico is the outlier in this group of economies. Until the late 1980s the Mexican development strategy aimed primarily at import substitution rather than export led growth, which influenced the pattern of foreign investment (Calderon, Mortimer and Peres 1996). However extensive privatisation, dismantling of protection and deregulation accompanied by liberalisation in the foreign investment regime in the late 1980s, significantly increased foreign investor participation in the Mexican economy. In 1989 the stock of foreign investment was some $24 billion. By 1993 this had risen to nearly $66 billion (Calderon, Mortimer and Peres 1996) with much of the new investment pouring into the privatised sectors of transport, telecommunications and energy and the EOIs in the Maquiladores (towns in the industrial zone just inside Mexico’s border with the US) (Castellanos 1999). As in Taiwan and Korea, it was not only domestic factors that led to the dramatic policy shift. To be accepted as an OECD member, Mexico needed to change its foreign investment policies to accord with the OECD’s code on liberalisation of capital movements. Preparation for entry into NAFTA in 1993 also required extensive revision of past policies. As a result of major policy redirection, Mexico has undergone what is arguably one of the most rapid transformations in national economic policy in recent times. Some attribute the crisis in the Mexican economy in late 1994 to such rapid liberalisation. As I discuss in the following section, the jury is still out on the question of the net benefits Mexico has gained as a result of the rapid increase in foreign investment. There seems to be general agreement that as a result of more liberal investment policies, foreign investors who were already in Mexico have significantly upgraded their plants. Calderon et al. (1996) suggest that auto

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plants in Mexico now compare favourably with similar US plants in terms of the technology they use. Similarly, many of the major electrical machinery and consumer electronics firms have upgraded their plants to a standard as modem as similar plants anywhere else in the world (Calderon et al. 1996; Castellanos 1999). However the evidence is more mixed on the extent to which such foreign investments have promoted the development of local industry. Lowe and Kenny (1998) have found a traditionally weak linkage between foreign investors and local firms in the electronics industry. The authors argue two key reasons. One is the tying in of Mexican plants to the international purchasing arrangements of their US parent companies and the other is geographic location of these plants in the Maquiladora zone along the US border. Calderon et al. (1995) show that imports greatly exceed exports for foreign owned firms, suggesting the possibility of low linkages with local firms. Business Mexico (June 1997) also suggests that most components of electronic production were imported because Mexican firms could not compete with the subsidised production of their East Asian competitors. The article suggests that more incentives and other government interventions were needed to help Mexican suppliers become more competitive. Hart (1997) agrees, noting the lack of government policies to promote either participation of local entrepreneurs or the development of indigenous technological capability. On the other hand Moran (1999), referring to earlier work by Peres (1990), suggests that the location of US auto plants in Mexico created jobs for high skilled workers. He says that within five years of establishing their plants in Mexico, some 310 local parts producers were established and foreign firms assisted these local producers to meet quality standards through regular training. Kokko’s work (1996) reinforces the impression that foreign invested firms have relatively poor linkages with local firms. He found there were few spillovers when foreign firms had much higher technology levels and market shares than their local counterparts but when foreign and local firms were more competitive with each other, the evidence of spillovers was more positive. It could be argued that as foreign firms have upgraded their levels of technology to world standards during the 1990s, it seems likely that - on Kokko’s reasoning - the potential of linkages with local firms may well have decreased. This possibility is reinforced by UNCTAD’s (1999a: 241) observations that although research institutes collaborate with industry in Mexico, it is foreign affiliates rather than local firms who most avail themselves of this facility. The authors of the

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UNCTAD report refer to research by Mortimer (1998) who found that in the auto industry plants were upgraded but the local supplier industry contracted. On the other hand, Moran (1998) refers to the work of Peres (1990) to argue that there have been reasonably good linkages in both autos and electronics. A possible problem with this argument is that the study by Peres is now dated and does not reflect the significant upgrading of plants carried out since more liberal policies were adopted. However the pioneering work of Aitken and Harrison (1994) on the transfer of international marketing capabilities suggests that linkages are not absent altogether. These authors found that local firms located close to foreign firms showed stronger export performance than other domestic firms. While the evidence is far from clear, a possible conclusion from the foregoing discussion is that Mexico’s switch to a more open policy on foreign investment has not yet fulfilled the potential to build strong competitive local firms. However as observers have noted of other examples, linkages with local firms take time and it could be argued reasonably that the relatively poor linkages so far are to some extent a result of Mexico’s prior reliance on an industrialisation strategy favouring import substitution. A shortage of evidence about the impact of FDI, the absence of consistent policy lessons, and differing opinions on the impact of liberalisation generally incline policymakers towards a more conservative approach to easing foreign investment restrictions. As we see in the following discussion, political pressures upon policymakers to move conservatively on this issue make such an approach even more likely.

Political Considerations in the Developing and Transition Economies Business Interests Business groups rarely speak with a unified voice on the benefits of investment liberalisation. There will always be some groups who are winners and others who are losers from the liberalisation process. Whether governments can move towards a more liberal investment regime depends upon the ability of those proposing the liberalisation to build successful coalitions to bring about policy change. Coalition building depends upon such diverse factors as the nature of the political regime in power, the

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pattern of business-government relations and the extent to which business groups are organised and unified. Even a united front from business may come up against popular opposition or opposition from within parts of the bureaucracy that stalls either a change of policy or implementing this new policy. Let us consider three examples from Southeast Asia to illustrate these arguments. The first example deals with opening foreign investment in the retail sector in the Philippines. The second looks at the financial sector in Malaysia and the third deals with the long delayed amendments to the Alien Business Law in Thailand. The law limiting ownership of retail outlets in the Philippines had its origins in the 1950s when the spirit of nationalism prevailing after independence from the US moved policymakers to exclude foreigners from large sections of industry. This was ostensibly to allow Filipinos to generate sufficient industrial strength that they could compete effectively with the foreign competition. There was also concern about possible Chinese domination of the retail industry. However, local Chinese business people circumvented this by applying for citizenship. The sector is still dominated by Chinese Filipinos (Sales 1996). The Ramos administration signalled in 1994 its plans to open the retail sector within the next two years (Philippines Political Monitor September 1994). In October 1995, a bill was introduced in the Senate to amend the law. There was widespread reaction to the proposed changes and it soon became apparent that complete opening of the sector would not be politically feasible. All interested business groups came up with their own proposals concerning the extent to which the sector should be opened for foreign participation. Submissions were made from the American Chamber of Commerce and Industry in the Philippines, the Australian and New Zealand Business Association, the Philippines Retailers Association, The National Economic Development Agency and the Philippines Chamber of Commerce and Industry. Those who favoured less rather than more liberalisation persuaded some members of congress that opening the sector would pose a significant threat to both local retailers and manufacturers. The end result was that in the absence of agreement on the extent to open the retail sector, the bill was defeated. A further attempt to open this sector was made by President Estrada in 1999 and again the move inspired claims that local retailers were not ready to compete with foreign competition (McDonald 1999). Those opposing change once again argued successfully that opening the sector would constitute a significant threat to locals who were not yet ready to compete

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with foreigners (FEER 30 December 1999). Coupling this proposed change to the foreign investment law with proposed constitutional amendments which would have allowed greater foreign ownership of land and public utilities, worked against those advocating the change. As public opposition mounted and the popularity rating of his government plunged, Estrada backed down (Labita 2000). The second example concerns opening the finance sector in Malaysia. There has been significant pressure on the Malaysian government to open its finance sector to greater foreign participation since the APEC process began (Bell 1998). Former Deputy Primer Minister Anwar Ibrahim was a strong proponent of policy change in this direction (Daneels 1997). Yet arraigned against Anwar was a coalition of interests consisting not only of Malaysian owned banks and insurance companies but also some elements within the bureaucracy. Locally owned banks argued that if 100 per cent foreign equity was allowed in the finance industry there would be less possibility of technology transfer (EAER July 1997), a position that pandered to the government’s well known policy strategy of using foreign investment as a tool to develop local industry. Some bureaucrats argued that opening the finance industry would place Malaysia in danger of becoming an economic colony of the wealthier nations (Bell 1998), echoing the sentiments that Mahathir himself raised in the immediate aftermath of the Asian crisis. The close linkage between the domestic finance industry and the leading government party UMNO (United Malay National Organisation) is a result of the banks serving as a key player in Malaysia’s industrial policy, a relationship that has developed elsewhere in the region as well. For as long as the Malaysian government continues to run an aggressive industry policy, it will need the support of the finance sector to channel funds into the sectors of the economy that national policy promotes. Financial sector liberalisation is therefore likely to be a difficult process since the government will continue to require the support of locally owned sections of the industry who most strongly oppose this policy change. The third example of difficulties in moving ahead with liberalisation is the amendment of Thailand’s Alien Business Law. As noted in Chapter 2, the Alien Business Law consisted of three lists of industries in which majority foreign ownership was denied or permitted only if a licence was granted. In 1994, then Prime Minister Chuan Leek Pai proposed an amendment to further open the Thai economy to foreign investment. In a number of articles between February and May 1995, The Bangkok Post

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reported on conflicts between members of the ruling coalition about the proposed changes. Most likely these members were echoing the sentiments of various business groups that would be negatively affected by the more liberalised policies. The foreign Chambers of Commerce were also divided. The US wanted to maintain its favoured position under the Treaty of Amity and Cooperation while other nations complained that the new changes did not go far enough. The proposed changes were finally approved by Cabinet in January 1997 (EAER January 1997) and were introduced into parliament in June 1997 (EAER April 1998). However, the onset of the Asian crisis delayed further consideration of the matter until the latter part of 1999. The legislation was finally approved by the senate and passed into law one day before Thailand’s senate elections in March 2000. However, the new law drew significant criticism particularly from opposition politician Chaovalit who had earlier accused the Prime Minster of selling out to foreigners (FEER 30 December 1999). The law is clearly a compromise and one that appears not to have completely satisfied either foreign investors or local business. The Bangkok Post reported representatives of local business saying that the new law was too liberal and raised the danger of local jobs being lost. On the other hand some foreign interests were quoted as saying that the best thing about the new law was that it was no more restrictive than the previous one. As noted in Chapter 2, the new law has a significant list of politically sensitive industries that are deemed to be not yet ready for competition with foreigners, including construction, large-scale wholesaling and retailing, and tourism. The legislation could thus be interpreted as a compromise by the government in favour of these groups. The three examples noted briefly above illustrate the pressures that governments face when they attempt to move towards a more liberal investment regime. Closer scrutiny of the liberalisation process would no doubt reveal numerous other examples of constraints imposed by business interests. It is inevitable that policymakers have to deal with such constraints and therefore any move towards institutionalising a more open investment environment will be longwinded and difficult. Bureaucracy For a number of reasons there are also problems for the liberalisation process from within the state itself. First, the various organs of the state

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have differing views on the extent to which liberalisation should and can occur within the existing legal framework. Second, the bureaucracy itself can be divided about liberalisation. The sources of division include the threat that liberalisation poses to bureaucrats’ own positions of power, their ties to entrenched interests that oppose the move, and the often serious competition within the bureaucracy for control over various areas of policy (Thomsen 1999). Again let us consider some examples from East Asia that help to illustrate these claims. As one of the major organs of the state in the Philippines, the Supreme Court has taken a conservative view of some major transactions concerning investment liberalisation and has held a number of transactions involving foreign investors unconstitutional. These include the sale of the Manila Hotel to Malaysian interests, the sale of a portion of the Philippines Long Distance Telephone company and awarding the Subic Bay port development to a Hong Kong company (FEER 20 February 1997). While the Supreme Court’s overruling of these transactions rested on its interpretation of the relevant laws, some observers have noted that if one wants to challenge a proposed foreign take-over, then some law or other can be found upon which to base such a challenge. The legal regime also posed difficulties for liberalisation in the mining and oil sectors (The Economist 29 November 1997) and privatisation of water supplies (International Financial Law Review March 1997). Thus, some of the difficulties posed here for liberalisation lie within the nature and functioning of an independent legal system that is itself the hallmark of a democracy. As Ramos speculated and subsequently discovered for himself, liberalisation is more difficult in a democratic setting but once liberalisation is under way then its effects are likely to be longer lasting (Tanzer 1994). Problems for liberalisation arise not only between the various organs of the state but also within the executive branch or the bureaucracy itself. We find signs of this in China and Vietnam Part of the problem lies in the great difficulty of transition to a market economy with different views within the governing communist parties about the pace of market liberalisation and the extent to which foreign investment should be allowed. Even if central authorities move towards a more liberal approach, bureaucrats at lower levels sometimes fail to implement the policies announced by the centre. Rosen (1999) notes that this continues to be a problem in China since local officials responsible for approving investments tend to look unfavourably on proposals if the officials perceive

116 Liberalising Foreign Direct Investment Policies in the APEC Region them to threaten local interests. On the other hand, if local officials see benefit from foreign investment, it is sometimes allowed in sectors that appear to be off limits according to central government policy. Rosen mentions examples of foreign investment in sectors as diverse as casinos, cellular phone operations, service stations, distribution companies and movie theatres, all of which appear to be restricted at a national level but where foreign investment can nonetheless be found in certain provinces. There are also inevitable conflicts between ministries with sector specific ministries seeking to protect the interests that they serve from being overwhelmed by foreign investors (Metal Centre News January 1999). There is also a reluctance to allow foreign investment in the telecommunications sector, largely because of this sector’s significance as a revenue earner for the state, and reluctance in the power industry because of the unemployment that would result in competitor state-owned power companies (Utility Business April 1999). Vietnam has similar problems within its bureaucracy, with some observers noting differences of opinion within the ruling party on the extent to which foreign investment should be allowed (The Economist 1 January 1995; Rivard and Ta 2000). Even when agreement is reached at the top, the efforts of policymakers are often frustrated by lower level bureaucrats who still are in the mindset of running the economy in command mode. Many commentators attribute falling levels of investment in Vietnam to the difficulties caused at local levels through the lack, or inconsistency, of implementing laws (Stiev 1999; Evans 1999; Singh 1998a; Mitchell 1997). The government itself has acknowledged the difficulties that local officials sometimes cause in this regard but it also points out correctly that in many cases failed projects are the result of foreign investors who have failed to do their homework before rushing in to capitalise on what is seen as a promising emerging market (EAER November 1997; Mitchell 1997). In the more developed Southeast Asian economies, investment agencies are often quite powerful within the overall bureaucratic framework, performing political as well as economic functions in screening foreign investment (Thomsen 1999; Conklin and Lecraw 1997). In a liberalised policy environment the role of investment agencies would necessarily decrease, along with the power that these agencies enjoy as a result of restrictive policies such as screening requirements and sector and ownership limitations. It may thus be quite difficult, even for governments

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with the political will and intent, to change the role of investment agencies from guiding foreign investment to simply facilitating it. Leaders and Popular Opinion In most countries there are always some groups of people who are opposed to a liberal foreign investment regime. In the previously colonised countries of Southeast Asia, there is a residual fear of foreign domination that those wishing to push the cause for a more liberal environment need to bear in mind (Thomsen 1999; Kofele-Kale 1992). Outbursts of nationalistic sentiment against foreign investment arise from time to time. In the aftermath of the Asian crisis this has been more conspicuous, particularly in Indonesia where leading politicians have called for foreign investors to make a greater contribution to the state as a result of the benefits they gain from exploiting Indonesian resources (McCawley 1999). Nationalistic sentiments have also posed problems for those attempting to arrange the sale of Indonesian state-owned companies to foreign bidders, particularly with popular concerns that these companies are being sold too cheaply (Ogden 1998). While such popular concerns tend to slow the liberalisation process, politicians may also play on these concerns for their own electoral purposes (Rugman and Verbeke 1998). Conklin and Lecraw (1997) note that political leaders may be happy to have restrictions such as joint venture requirements because they provide simultaneously a ready means for politicians to convince voters that the government is acting to ensure national benefit from foreign investment and for the government to hand out favours to supporters. Finally we must not overlook the growing power of the Internet as a device for citizens movements opposed to foreign investment liberalisation. Spar (1999) suggests that the operations of multinational companies are now under the spotlight even more than before, and improved communications worldwide will enable oppositionists to pressure these companies if there is any sense of malpractice. She argues that this will force foreign investors to take much greater care with the conditions for workers and the environmental impact of their operations. In a broader sense there appears to a growing international movement against globalisation as evidenced by the protests against international meetings that are perceived as aiding this cause, including meetings of the WTO, the World Economic Forum and the IMF. If this movement continues to gather

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force, it will exert further pressure on politicians not to move quickly towards liberalising foreign investment policy. In any event politicians will need ever more to have solid evidence at hand to convince non-supporters of the beneficial effects that will result from a more liberal foreign investment policy. As this chapter has revealed, however, this evidence is as yet piecemeal and appears to be in short supply.

Conclusion This chapter has canvassed the reasons for continuing restrictions on foreign investment. It has shown that in the developed economies and the NIEs, political reasons appear to predominate, with national security considerations justifiable only on very narrow grounds. If Graham and Krugman’s analysis of the US example is applicable to other economies in this group, then maintaining restrictions on economic grounds cannot be justified. In the developing and transition economies, the position is more complicated. Here there is a risk that foreign investment might cause negative economic effects because of the relative underdevelopment of local firms and capabilities. However, as we have seen in this chapter, there is no consensus on the extent to which this negative impact occurs. Neither is there consensus on whether negative effects are more likely to be avoided in a more or a less liberalised policy environment. The approaches to foreign investment adopted by the NIEs in the earlier wave of developing economies provide limited lessons for policymakers today because of the variety in the policy approaches that the NIEs adopted and the very different international economic climate that prevailed at the time their economies flourished. Further, in the cases of Korea, Taiwan and Singapore, the state had the authority to both formulate and implement policies to achieve its desired objectives. With increasing démocratisation, this capacity has been weakened not only in these countries but also in others in the region. The question, then, is what can APEC do to overcome the constraints identified in this chapter? As APEC has little sway in domestic politics, all that can be done is to attempt to convince groups within these countries of the benefits of foreign investment. It is here that the problem lies. There is simply insufficient information available for APEC to argue convincingly

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about the benefits of liberalisation. More research therefore needs to be undertaken to assist APEC’s cause in this regard. First, the method of analysis used by Graham and Krugman could be used for each of the developed countries and NIEs to establish whether economic justifications for continuing restrictions are as unsustainable as they are in the US. Second, much more research along the lines of Crystal’s analysis needs to be undertaken for countries in this group. The political constraints on further liberalisation are likely to assume increasing importance in the light of movements against globalisation. The concerns of those opposing liberalisation need to be aired and those concerns dealt with through other policy measures rather than allowing the continuation of restrictions that may, in the long-term, cause even those opposing liberalisation more harm than good. Third, a database of the existing case studies on the impact of foreign investment in developing economies needs to be compiled for the region. Policymakers could use this to convince opposing groups of the benefits of liberalisation and appropriate policies that might be needed to accompany it. This database could be supplemented with further case studies oriented towards the role of foreign investment in building internationally competitive firms in each economy. Fourth, a common awareness of the political problems faced in other countries might assist policymakers in cogently promoting the benefits of liberalisation to those who oppose it. Comprehensive studies on the political constraints in developing countries are difficult to find, if they exist at all. Policymakers in individual countries are no doubt aware of their own political constraints and if further research was carried out in this area, the commonalities of concerns might be enlightening. The current lack of sound empirical evidence to support the benefits of liberalisation is therefore a major constraint to achieving the Bogor goals of a free and open investment environment by 2010 for the developed economies and 2020 for the developing economies. If such evidence is not forthcoming, the liberalisation process may be in danger of stalling. Arguments relying on economic theory alone will not be sufficient to sway the gathering forces opposed to liberalisation.

4 The Neglected Issue of Investment Incentives Introduction Countries in the APEC region compete actively for foreign direct investment in priority manufacturing industries, high technology activities, employment creating projects and to develop underdeveloped regions. Governments offer investment incentives in attempts to attract investment into one or more of these areas. This chapter examines in detail the range of incentives that some of the countries in the region offer. Developing economies tend to use tax holidays, tax reductions, import duty concessions, and special economic zones (SEZs), while developed economies generally rely more on outright grants and subsidies. This chapter shows that even tougher competition to attract FDI has resulted in very generous incentive packages for investment that accords with host country priorities. Yet economists are almost unanimous in their condemnation of these incentives and consider them to be largely ineffective in attracting foreign investors. If incentives do have some effect, there is the risk that they will distort patterns of investment away from what the market would have produced, resulting in a misallocation of resources. Further, incentives involve considerable loss of revenue to the state. This revenue could be better used in enhancing skill levels within the local population and in providing much needed infrastructure. The tax incentive game is weighted in favour of the developed countries, for two reasons. First, grants are more highly prized by multinational companies than tax concessions. Second, the tax concessions that developing countries give to investors often amount to a subsidy to taxpayers in the richer countries from which investment originates because, if the developing country does not tax the investor’s income, it is likely that the home country will do so when the income is remitted to shareholders. It could be assumed then that developing countries in particular would be highly motivated to see some reduction in incentives. Yet, despite many suggestions as to how this might occur, little action is taking place. 120

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Governments fear losing out to competitors if they take unilateral action, political will to reduce incentives is weak, and it is difficult to convince the investment agencies that administer the incentives that they should abandon this policy tool. I have obtained the information that I discuss in this chapter concerning the incentives offered in the region from the APEC investment guide. This information is supplemented with information available from the websites maintained by the investment agencies of most countries. In many cases the information available on the websites is far more comprehensive than that in the Investment Guidebook. This points to a further shortcoming of the guide and another area where the guide could be improved.

Competition for Investment in Priority Manufacturing Industries Competition for foreign investment in priority industries is most intense in the ASEAN region. Malaysia, Thailand and the Philippines have extensive lists of priority industries that entitle investors establishing in those industries to generous tax incentives in the form of tax holidays, special tax deductions, import duty concessions and exemption from other taxes and charges. These lists consist primarily of manufacturing industries. Because China is also seeking investment in manufacturing activities, China too is drawn into the investment competition, granting foreign investors tax holidays, tax rate reductions and import duty concessions for investment in ‘productive’ enterprises. Indonesia has not given tax holidays to foreign investors since 1984 despite plans in recent years to do so. In response to tighter competition in the region for foreign investment, reintroducing tax holidays was mooted in 1995. In 1998, the Indonesian government announced a plan to offer tax holidays for between three and 12 years for firms engaging in activities on a pioneer list and that satisfy certain other specified criteria. Subsequently, however, under pressure from the IMF, the Indonesian government announced the abandonment of its plans for tax holidays. A brief examination of the tax holidays available to investors in priority industries demonstrates the generosity of the incentives as well as the competition that exists between countries, which helps to explain this generosity. Malaysia offers investors in industries on its pioneer industry list a tax holiday for five years to the extent of 70 per cent of income. As an alternative it offers an investment tax allowance of 60 per cent of capital

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expenditure that can be offset against 70 per cent of statutory income over a five-year period with a carry forward provision. This alternative is provided for those firms with high levels of initial capital expenditure in the set up stage. Thailand also offers tax holidays for investment in its list of promoted industries. The length of the tax holiday is more generous than in Malaysia and varies between three and eight years depending upon the location of the project as I discuss below. In some cases the tax holiday may even be extended beyond eight years. The Philippines’ Investment Priorities Plan sets out a large number of manufacturing industries, dividing them into pioneer industries and non-pioneer industries. Pioneer industries are eligible for a tax holiday of six years while non-pioneer activities are eligible for a four-year tax holiday. The tax holidays may be extended for up to three years if certain conditions are met. China offers a standard two-year tax holiday and a further 50 per cent reduction for three years to the firms that are regarded as productive enterprises. The definition of what amounts to a productive enterprise varies from time to time in accordance with state industry policies. China also offers five-year tax holidays to high priority investments in infrastructure industries in certain locations and shorter term tax holidays for some priority service industries. While foreign investors in priority industries are often eligible for tax holidays and other concessions, those who invest in export oriented manufacturing industries receive a range of additional privileges. WTO requirements concerning the elimination of TRIM have resulted in phasing out some of the export conditions that were attached previously to granting incentives. Thailand, in particular, moved to revise its incentives to comply with WTO requirements in August 2000. However, the following analysis shows that export oriented investment in manufacturing sectors in most countries still attracts a range of special incentives. These take the form of reductions in tax rates, special tax deductions related to export activities, concessionary rates of import duty on raw materials, machinery and spare parts, as well as infrastructure advantages provided in the form of special export processing zones. To illustrate, let us compare some of the incentives offered to export oriented investment. Both China and the Philippines offer special tax rates to export oriented foreign investment locating in special zones. These conditions apply to all investment considered to be export oriented regardless of whether this investment may also be eligible for tax holidays. Needless to say, the tax holiday provisions are more generous than tax rate concessions and

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accordingly if firms have the choice they may opt for the tax holiday provision. As will be seen however, the absence of tax sparing provisions in double tax agreements between the home and host countries may mean that tax holidays are not always an attractive option. In the Philippines, the act establishing the export processing zones contains tax reduction provisions. An exporter locating in the zones obtains a special tax rate of 5 per cent of their gross income in lieu of paying the normal company tax. In China, even if an export oriented firm does not qualify as a productive enterprise, it will still be eligible for the special tax rates that apply if it locates in one of the economic zones. The tax rate in the SEZs and technological development zones is 15 per cent and in the open cities the rate is 24 per cent. In addition to tax holidays and special tax rates, some of these countries offer a range of other tax deductions and tax credits for exporters. If firms are eligible for full tax holidays, these deductions might have limited utility during the tax holiday period. Malaysia offers a double deduction for various export-related expenses and an export credit-financing scheme. The Philippines offers tax credits on a sliding scale for increases in export income. To qualify as an exporter at least 50 per cent of production must be exported. Thus, exporters who increase their export income by 5 per cent to 15 per cent obtain a tax credit of 2.5 per cent of the increased amount, while for exporters increasing their export income above 15 per cent, their tax credit increases to 10 per cent of the value of the increased export sales. Another measure used to encourage export oriented investment is the exemption of raw materials and machinery from import duty. Indonesia allows a rebate of duty on goods and materials used to produce products for export regardless of the availability of these goods and materials locally. Thailand also offers significant reductions in duty on raw materials and machinery depending upon the location of the investment. It has phased out the requirement that firms must be exporters to avail themselves of import duty concessions. The Philippines allows exporters to obtain credit for taxes and duties on the raw material and other inputs used to produce exports and offers exporters simplified customs procedures. China abolished its exemption of duties on imported machinery in 1994 but reinstated this in 1998 for foreign investors in encouraged areas. Malaysia exempts exporters locating in its free commercial zones from import duties and simplifies customs procedures.

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A discussion of incentives for exporters would not be complete without a discussion of the infrastructure facilities provided to foreign investors in SEZs. The number and type of these zones has proliferated in recent years. Malaysia introduced the free trade zone concept in the 1970s following the lead of Taiwan and Korea. These zones have been highly successful in attracting export oriented production particularly in the electronics industries. Currently Malaysia has three types of zones. The first type free industrial zones - operates in a similar way to free trade zones, allowing minimal customs duties and procedures in relation to exporters who import materials for manufacturing for export. The second type is the free commercial zone designed for bulk import of goods to be repackaged for export. The third type of zone takes the form of licensed manufacturing warehouses that are essentially smaller versions of free industrial zones. Indonesia has emulated Malaysia’s free industrial zones by establishing bonded zones where exporters have the advantage of the free import of goods and material required for export production as well as simplified customs formalities. The most significant of Indonesia’s bonded zones are located in Jakarta, Surabaya and Battam Island, which aims to take advantage of its close location to Singapore to attract companies looking for both the expertise and services that Singapore can offer combined with the cheap labour of Indonesia. As an added incentive for investors, Indonesia has recently relaxed its policies to allow investors to sell up to 25 per cent of their output in the domestic market as well as allowing companies to lease machinery to subcontractors outside of the bonded zone for up to two years. The Philippines also introduced special export processing zones in the 1970s but the four that were established amounted to simply assembly operations for export (Flamiano 1993). The zone concept was revived in the late 1980s, particularly when the Ramos government came to power in 1993. Not only were the former US bases converted to SEZs but also a special Philippine Economic Zone Authority (PEZA) was established in 1995 with the aim of introducing regional industrial zones into each province. Private industrial estates were also developed, with some having a form of export processing zone attached. The zones have been reasonably successful in attracting investment; investment levels rose from 69 million pesos in 1986 to 2.6 billion pesos in 1993. The number of firms in these estates also increased from 56 in 1986 to nearly 300 by 1993 (Mendoza 1995). The zones have also contributed significantly to employment creation and in the case of Subic and Clarke have provided a major

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alternative form of employment to those who were employed by the US base authorities. However, the expansion in the number of economic zones has not been without criticism since these zones involve loss of land used hitherto for agricultural purposes (Flamiano 1993). China introduced its SEZs in the early 1980s, establishing six dotted along its coastline. Since then the number of zones and their functions have proliferated. In addition to the original six SEZs, by 2000 there are economic and technological development zones, free trade zones, open coastal cities and special zones in the western part of the country. The central administration appears to allow provincial authorities a fairly free hand in developing their own zones. Each zone is an attempt by regional authorities to attract foreign investment into its own province and the regional authorities often offer special incentives in addition to the standard national incentives discussed previously. How do these incentives demonstrate competition for investment? First, the level of generosity of the incentives - particularly tax holidays appears roughly similar across all countries. Second, as Chia and Whalley (1995) demonstrated, the levels of incentives have been increased over the years, particularly in the ASEAN countries. At the same time, the Latin American countries have moved to keep up with the competition by introducing incentives for export processing activities. Peru offers exemption from income tax, general sales tax and excise tax in the export centres located in the coastal towns of Ilo, Matarani, Tacna and Paita. Mexico and Chile allow exporters meeting certain criteria exemption from import duty and value added tax. Third, there is considerable similarity in the type of incentives offered - tax holidays, special deductions, import duty rebate and zones - rather than, for example, outright grants or subsidised loans. Yet there is also a degree of ‘product differentiation’ within each category of incentive as countries attempt to make themselves look slightly more attractive than their competitors. However, this product differentiation is also the result of attempting to use tax incentives not only to encourage export oriented investment but also to pursue other goals at the same time. For example, Thailand varies the length of its tax holidays depending on where a business locates within the three broad zones into which the country is divided. Generally, the further from Bangkok the more generous the incentives. Thus Thailand uses tax incentives not only to encourage exports but also to achieve regional development goals. Until mid 1998, Malaysia tied the level of exports to the level of foreign ownership that was permitted. Thus firms

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exporting more than 80 per cent of their production could have 100 per cent foreign ownership. Those exporting between 50 per cent and 70 per cent could have foreign ownership of 50 per cent to 70 per cent and so on. Thus, in addition to providing tax holidays, Malaysia also relaxed its usual limits on foreign equity in an attempt to attract export oriented investment. The Philippines also attempts to achieve multiple goals with its incentive policies. We noted above that the incentives are more generous if one is not only an exporter but is also engaged in a pioneer activity. Thus, the Philippines attempts to encourage export oriented investment and develop so called priority industries via tax incentives. Indonesia’s policies of allowing companies in bonded zones to lease equipment to subcontractors outside the zone is an example of attempting to have foreign investors not only contribute to exports but also assist in training indigenous firms. Finally, countries appear to watch each other’s moves carefully to keep up with the competition. For example, one-stop shops for investment were established at similar times in Indonesia, Malaysia, Thailand and the Philippines to ease the administrative burdens necessary for investors to establish an operation.

Competition for Investment in Underdeveloped Areas Not only do the countries mentioned above compete for foreign investment in priority manufacturing industries but they also aim to entice foreign investors into the less developed regions of their economies by offering slightly more generous incentives in those areas. Thailand offers the best example. As noted above, Thailand’s incentives become more generous the further one moves from Bangkok. In the early 1990s the country was divided into three broad investment zones. The least developed areas of the country fall into Zone 3 where investors receive the most generous tax holidays and the most significant reductions in import duties. Successive Thai governments have hoped that by offering more generous incentives to attract foreign investment into underdeveloped regions, this investment will collectively play a significant role in modernising and developing these regions. In its most recent package of incentives, Thailand has divided Zone 3 provinces into two groups, giving even more generous incentives to the new fourth group that comprises the most underdeveloped provinces.

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Malaysia offers more generous incentives for investors locating in the eastern states and in Sarawak and Sabah where the tax holiday applies to 85 per cent of statutory income rather than the 70 per cent of income in the western states. When tax holidays were first mooted in Indonesia, the eastern provinces of the country were to be the major beneficiaries. The Philippines also offers more generous tax holidays for investors locating in designated underdeveloped regions such as Mindanao where the length of the tax holiday is a standard six years. In recent years, China has also attempted to attract investors to the inner regions of the country and away from the coastal areas. However, the formulation of specific policies has been left largely to provincial authorities. Later in this chapter we observe that this pattern has also emerged in the larger and more developed countries in the APEC region. It appears therefore that China may be following the lead of these countries in courting investment at the sub­ national level. But as I demonstrate later in discussing the more developed countries in the region, this policy may prove costly. The Latin American countries of Chile and Peru also provide incentives for firms locating in underdeveloped areas. Peru offers exemption from income tax for a range of activities in the Peruvian Amazon region. Chile’s entry in the Investment Guidebook states that it does not generally grant tax incentives but it nonetheless does allow for exemption of income tax and value added tax for firms establishing in ‘certain extreme areas of the country’. Accurate assessment of the effectiveness of these policies in inducing investors to establish in remote locations requires detailed analysis of investment patterns. Even if data on the regional breakdown of investment was available, it would still be difficult to attribute the investment in underdeveloped regions directly to the incentives rather than, for example, the location of major resources in the area. Since we cannot produce this evidence we need to fall back upon the general arguments about incentive effectiveness canvassed later in this chapter.

Competition for High Technology Investment Korea, Taiwan and Singapore pioneered the use of investment incentives in earlier stages of their industrialisation and all three countries have continued this practice in attempts to upgrade their technological capabilities to developed country standards. An examination of the

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incentives offered by these countries shows intense competition for investment that introduces the most recent technology. All three countries make extensive use of tax holidays, exemptions of tax on royalty payments, generous deductions for R&D expenditure as well as special high tech parks in order to entice the most modem and technologically sophisticated MNCs. The types of firms eligible for tax holidays are selected carefully by screening agencies in each country. In Taiwan, it is desirable to demonstrate that the investment falls into the category of one of 10 emerging industries: communications, information, consumer electronics, semiconductors, precision machinery, aerospace, advanced materials, speciality chemicals, medical and health care and pollution control. After the screening authorities indicate they are satisfied that the investment is an important technology enterprise, a five-year tax holiday will be available. Alternatively, if the company meets the criteria for locating in the Hsinchu Science Park it will also be possible to receive a five-year tax holiday. Taiwan complements its tax holidays with both low interest loans for companies that meet detailed criteria and exemption of withholding taxes on royalty payments. For firms not eligible for tax holidays, Taiwan offers tax credits ranging from 5 per cent to 20 per cent of expenditure on certain activities involving upgrading technology, R&D, personnel training and the establishment of an international brand image. Korea has been making efforts to encourage high technology industries since the early 1990s when it introduced a tax holiday for firms in specifically listed industries. The generosity of the tax holiday provisions has increased twice in recent years with the length of the holiday extended from three years to five years and more recently to seven years with a further three years at the 50 per cent rate. The list of ‘high technology’ activities has lengthened to now encompass firms that engage in any one of some 436 business lines. Korea has also listed 97 service businesses, which will qualify for tax holidays on the basis that they provide services to high tech firms. An examination of this list shows that the types of activities eligible for tax holidays could be grouped into the broad categories listed by Taiwan. Like Taiwan, Korea also provides withholding tax exemption on royalties and provides infrastructure in the form of high technology parks. These have only been developed since the mid 1990s while Taiwan’s Hsinchu park was established in the mid 1980s. Korea also allows provincial governments to exempt high technology firms from property tax, acquisition tax, land tax and registration tax.

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Singapore offers a generous 10-year tax holiday for firms considered by the Economic Development Board to fall into the pioneer industry category. As with Taiwan and Korea it also offers withholding tax exemption on royalties. The government funds an innovation development scheme providing 30-50 per cent of the development costs for innovative products or processes that lead to a significant contribution to the relevant industry. The Economic Development Board also has a venture capital fund, which may provide finance to promising companies in high technology areas. Further, double deductions are available to all investors for R&D expenditure. The incentives offered by all three countries demonstrate a high level of competition for investment in high technology areas. However, as was the case with competition by developing countries for manufacturing investment in priority industries, these countries also seek to pursue other goals with their incentive policies. For example, a close reading of Singapore’s long list of investment incentives suggests a number of policy goals. The first is to attract large new projects from significant multinational companies in the petrochemical, electronics and engineering fields as evidenced by the facilities and incentives offered in conjunction with the Jurong Island development (Singh 1998b). A second goal is to assist Singapore’s ailing small and medium enterprise sector to become more globally focused. Small and medium enterprises are being encouraged to upgrade technology via an enterprise development fund and accelerated depreciation allowances for new capital equipment. They are also being encouraged to become more globally focussed with a range of deductions for international market development. A third policy objective seems to be to encourage local R&D by multinational companies with generous deductions provided for R&D expenditure, a research incentive scheme and the patent application fund. A further objective is to upgrade Singapore’s entrepot role to make the island state a major regional operations centre. Incentives are offered to encourage international counter-trade, international shipping companies and international airlines to locate in Singapore. To complement its moves in this direction, Singapore has been reported to be offering tax holidays to international fund management and investment banking companies (Surry 1999). In this respect Singapore seems to be in direct competition with Hong Kong’s desire to maintain itself as a regional financial centre and with Taiwan’s aim to become an Asia Pacific Regional Operations Centre.

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An examination of the range of incentives offered in Korea also suggests goals beyond the establishment of new high technology companies. The range of incentives able to be offered by provincial governments suggests that Korea is pursuing regional development as well as technological deepening through its incentive program. However, the proliferation of incentives at a regional as well as national level may yet result in a costly bidding war as has occurred between states in the US and between European countries. Competition for high technology investment has spread to the newer NIEs in recent years. Malaysia is perhaps the most aggressive of the newer NIEs in promoting investment in high technology areas. The best example of this is Malaysia’s plan for a multi-media supercorridor. Companies that are approved to locate in the supercorridor are entitled to a tax holiday for 10 years. In other high tech industries, foreign investors are eligible for a full tax holiday for five years. Malaysia also offers generous tax deductions for R&D expenditure and a five year tax holiday for R&D service companies. The level of incentives offered by Malaysia matches the level offered by Singapore. Even Senior Minister Lee Kwan Yew is quoted as saying that Singapore faces intense competition from Malaysia in the high tech investment area. Lee makes the point however that Singapore’s superior information technology infrastructure gives the island state a considerable advantage over its competitors (James 1997). Thailand is also competing for investment in high technology industries. Projects related to technological and human resource development have priority status with a number of specific activities that qualify under this broad heading appearing on the promoted industry list. In an attempt to upgrade technological capability in manufacturing activities, Thailand now imposes requirements on all investment projects desiring incentives that they produce certification that they meet international quality standards. It is apparent that many countries in the region are keen to attract high technology investment presumably on the basis that this investment will lead to considerable spinoffs for the development of local firms. However, as we have seen these spinoffs are not guaranteed and depend to a large extent on both the capability and willingness of local firms to absorb the technology that is introduced and the willingness of foreign firms to transfer it. Thus, the level of incentives provided may not necessarily be cost effective. I discuss this point in more detail below.

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Competition for Regional Headquarters A further example of the competition for investment that occurs in the region is the attempts by some of the smaller but more developed members to promote themselves as a suitable base for establishing regional headquarters (RHQs). The advantages of attracting RHQs are that they provide impetus to the goal of internationalising the domestic economy through demonstration effects to local firms and through the managerial and marketing expertise that they bring. In addition they may also be encouraged to do much of their R&D for the regional market in the country where the RHQ is located. Singapore, Malaysia and Australia are in competition to establish themselves as the best location for the headquarters of multinational companies with operations across Southeast Asia. All three countries offer incentives for RHQs although all have reasonably strict criteria as to what qualifies as an RHQ. Australia defines RHQs as those companies that provide services in the form of management (finance, business planning, marketing), data services or software support services to associated companies located overseas. Malaysia has a stricter set of criteria including a m inim um paid up capital as well as a minimum number of companies that need to be serviced offshore. In addition, RHQ companies must provide a range of services. Singapore has similar criteria to those of Australia. For companies that qualify as RHQs, both Singapore and Malaysia exempt corporate taxes for 10 years and exempt dividends paid out of profits from any form of tax on those dividends. Australia is comparatively less generous but does allow RHQ companies to deduct their set up costs from income and matches the exemption from withholding tax on dividends offered by Malaysia and Singapore. Australia also relaxes its fairly stringent visa conditions for executives of RHQs. Despite the less generous nature of these incentives, Australia has performed reasonably well in attracting RHQs, particularly to Sydney. Corporate Location noted in 1996 that some 70 RHQs had established in Australia since 1993 bringing the total to over 240 RHQs within the country. This number has grown considerably since 1996 so that in Sydney alone there are now well in excess of 200 RHQs. The relative success of Sydney as a base for RHQs in light of the relatively less generous incentives provided by Australia demonstrates that incentives may not necessarily be a major determining

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factor in decisions about where to establish RHQs. I return to this issue later in the chapter.

Employment In the more developed countries in the APEC region, a major attraction of foreign investment is that it provides employment. However, positive employment effects of greenfield investment are much easier to demonstrate than those of M&As. For this reason, developed countries in the region compete actively for large new investment projects. Much of this competition does not occur at a national level but at the sub-national level where states or provinces within countries sometimes offer huge sums from public revenue to MNCs to induce them to set up there. These sub­ national agencies are left to make their own assessment of the costs and benefits of the subsidies they provide. However, regardless of the economics, the political advantages of attracting major new projects are immense, as these projects tend to be picked up by the media and gain for the government favourable publicity and votes. With generally high levels of unemployment in many regional areas of developed countries, any initiative that is seen to create employment is usually acceptable to a large percentage of the population provided the project does not offend environmental concerns and is in a field where locals are not overly threatened by the competition. Most of the reported cases of competition between sub-national agencies come from the US where states compete actively for major new investment projects in high profile industries with large potential for spinoffs, including chemicals and automobiles. Comitus (1997) has illustrated the competition between Louisiana and Texas for a major Japanese investment in the chemical industry. He notes that to secure the investment Louisiana offered a $129 million tax package including a 10 year industrial tax exemption, a rebate in sales and excise taxes, together with a corporate income tax credit of $2,500 for each new job created. The Economist (16 December 1995) provides figures on competition between US states in the automobile industry. These figures show that to outbid Tennessee and Nebraska for a Mercedes Benz plant, Alabama had to provide $250 million worth of handouts. Similarly, to secure a BMW plant, North Carolina provided $130 million in subsidies. The Economist argued that the subsidies provided far outweighed the potential benefits.

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Moran (1998) indicates that the total costs of incentive programs in the US has been estimated at $20 billion annually in the late 1990s, rising from an estimated $11 billion in 1989 and $18 billion in 1993. He points out that some 36 states in the US provide subsidies for greenfield investment with the average grant per project in the order of $50 million to $70 million. In some cases, the subsidy package offered by state governments amounts to some 60 per cent of the capital cost of the project. However, the practice is also widespread in Europe where both France and Germany commonly offer incentives of 25 per cent of the capital cost. There are some indications that other countries in the region are moving towards the provision of subsidies at the state or provincial level. All Australian state governments have departments of State development that compete actively with each other for major new investment projects particularly in the services sector. A recent example is the competition between Queensland and Victoria for the Australian base of Virgin Airlines. Japan has also moved in recent years to have provincial governments play a much larger role in attracting investment, not only through grants but also through establishing special foreign access zones where foreign companies are provided with infrastructure subsidies and assistance with staffing, packaging and import clearance to enable them to more easily penetrate the Japanese market. While the aim of these zones has been ostensibly to increase the level of imports into Japan, a more important objective has been to encourage regional development within Japan. Korea appears to be following the Japanese model with its recent initiatives to encourage competition for investment at the provincial level. In particular, the Korean national government allows provincial governors to exempt a wide range of local taxes, and its foreign investment zone concept encourages provinces to attempt to attract major projects into their regions. The foreign investment zone concept allows a single investment project to be given a substantial tax holiday provided it makes a very large capital investment that also creates a minimum of 1,000 jobs. China also appears to be moving towards competition among provincial authorities for foreign investment with moves beyond the incentive structure provided by the national government. To attract foreign investment into the inner provinces, the Chinese central authorities appear to be moving towards the view that much of the initiative will have to come from local provincial authorities. One suspects that the Chinese authorities would now like to shift incentives to inner regions of the country, away from coastal areas where foreign investment has

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concentrated over the past 20 years. As early as in 1994 there were announcements that China was seriously considering abandoning its incentive program, accompanied by statements to the effect that China would like to see more foreign investment in the inner provinces. However, internal political difficulties with this course of action together with the competition for investment from Southeast Asian countries make this shift a difficult option. Thus China appears to have taken the stance for the time being that inner provinces must play a considerable role themselves in providing inducements to foreign investors to locate there.

The Case Against Tax Incentives The discussion above reveals that the use of incentives is widespread in the APEC region. The East Asian members of the group in particular tend to make significant use of tax incentives including tax holidays, tax rate reductions, investment allowances, import duty concessions and SEZs in an attempt to attract investment. Yet there is almost unanimous agreement among economists that such incentives are largely ineffective. One would therefore expect that incentives, along with formal barriers to entry, should be the subject of reductions on the APEC investment agenda. Before advancing some reasons why there is so little action in APEC about the proliferation of incentives, we should first review arguments by those who suggest incentives are ineffective. One argument against tax incentives is that they have little influence on the investment decisions of international firms. After several decades of survey and econometric research, economists have concluded that incentives play only a minor, if any, role in attracting investment. Reviews of the literature by the United Nations Centre on Transnational Corporations (UNCTC) (1991) and UNCTAD (1996) arrive at the conclusion that other features of the investment environment including market size, cost factors, skill levels, political stability and the economic and regulatory framework all matter far more in firms’ investment decisions. Nonetheless, much of the literature (IMF 1985; OECD 1983, 1993; World Bank 1987, 1993, 1994; UNCTC 1992; UNCTAD 1996) acknowledges that if it comes to a choice between largely similar locations with all other factors tending to be equal, then investment incentives may act as a ‘tiebreaker’ in the investment decision of multinational firms. However, Guisinger (1995) makes the point that in practice, firms often

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choose among sites that are quite different and hence it is rare for incentives to tip the balance. It has also been established (Pfefferman 1991; Guisinger 1985) that even when incentives play some part in investment decisions, they tend to do so for export oriented investment much more so than for domestic market oriented investment. Moreover, Porcano et al. (1996) found that while investment incentives might affect the type of investment, they do not affect its timing or the intended investment project amount. Thus economists have often questioned whether tax incentives amount to states losing more revenue than they gain from incoming investors. Anwar Shah, who has spent over two decades working on the relationship between tax and investment, concluded in his 1995 work that both tax holidays and tax rate reductions significantly below rates prevailing internationally are likely to result in more revenue loss than revenue gain. He also points out that investment authorities are reluctant to divulge the exact cost of incentives, even if they know this figure. One estimate suggests that tax incentives in the Philippines in 1988 might have amounted to as much as 1 per cent of GDP (Chia and Whalley 1995) which seems an extraordinary amount to give away to foreign companies that might have established their project in the Philippines in any event. Given the competition for investment within the ASEAN group and the range of incentives that the ASEAN nations offer, it seems likely that revenue losses in Malaysia, Thailand and Singapore may also be considerable. Other arguments against the effectiveness of tax incentives, particularly tax holidays, are more technical. One argument is that the effectiveness of a tax holiday depends to a considerable extent on whether the investor’s home country and the host country have a tax sparing provision in their double tax treaties. If there is no such provision and the investor does not evade or avoid tax, then it is likely the investor will in any event have to pay tax in their home country from the investment due to worldwide incomes tests. This reduces the attractiveness of the tax holiday. It has been noted that while there are tax-sparing provisions in many of the treaties between Japan and other countries in the region, the US has no tax-sparing clause in its double taxation treaties. It has even been argued that this may place US investors at a disadvantage to their competitors (Martin 1998). Following the US lead, Australia announced in 1997 that it would phase out its tax sparing provisions when double tax treaties come up for renegotiation.

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Further, tax holidays for large capital projects may not be as useful to investors as a combination of investment allowances and loss carry forward provisions. Here the reasoning is that investors may be better off if they can obtain tax deductions for large capital expenditure items to offset their tax in the early years or carry forward any losses that they make well into to the future, rather than be tied to a set tax free period that often starts with the firm’s first production rather than its first profits. Some countries, such as Malaysia, have taken the point on board by offering investment allowances as alternatives to tax holidays. Closely related to this argument is that tax holiday provisions may favour investment that is short-term (Guisinger 1995; Shah 1995) since when firms have to start paying tax they may relocate their operations elsewhere. When we couple this observation with the earlier observation that tax holidays are really only useful to export oriented firms, we recognise that tax holidays may encourage footloose investment that focuses on assembly, with little potential for contributing to technology capability and skill development in local firms. As we saw in Chapter 3, this is one of the key advantages that host states seek to gain from foreign investment. Yet, it may be that tax incentives actually work against this policy objective. Further research will therefore be useful to establish the extent to which tax holidays generate footloose assembly production within the APEC region. It has been suggested that some assembly focussed firms in Malaysia have followed this pattern in relocating to cheaper locations in Indochina. Those who argue that these types of incentives are necessary to compensate foreign investors for low rates of return in the early years of the project therefore need to consider the possibility that tax holidays also encourage short-term investment. Another argument is that if tax holidays do influence investment, they may simply skew the pattern of investment towards investment that does not rely heavily on depreciable factors of production and that relies more on equity than debt (Mintz 1995). Here the reasoning is that if a firm cannot write off its capital expenditure or its interest payments, then it is less inclined to emphasise capital expenditure or borrowing to establish its investment. Much more work is required to assess the extent to which incentive packages are distorting patterns of investment. This is important because, as noted earlier, barriers to foreign investment have been reduced significantly. If this trend continues, incentives may become a key feature that distinguishes the investment environment between countries, which

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could result in incentives having a greater distortionary effect than they do at present. Another argument against tax holidays concerns the signals they send to foreign investors. It is sometimes suggested that tax holidays are a useful device to signal internationally that a country is open to foreign investment. This claim seems plausible on first impression but (Lim 1983) has argued that investors see generous incentives as a warning rather than as a lure. A recent study by Raff and Srinivasan (1999) tends to support this argument by establishing that the greater the risk, the smaller the domestic market and the smaller the stock of existing investment, the more likely it is that incentives will be used in an attempt to attract investment. Shah (1995) also notes that foreign investors may interpret very high incentive levels and tax rate reductions as a sign that the tax rate will have to rise in the future to compensate for overly generous incentive packages. Other commentators (including Shah 1995; Brewer and Young 1997; Chia and Whalley 1995) argue that once incentives become accepted as a part of a country’s industry policy these incentives tend to proliferate as domestic industry groups lobby to be included as recipients. This is particularly the case where investment incentives are available to both domestic and foreign investors alike. Most countries in the region do not now discriminate between foreign and local investors over incentives and accordingly if local firms had intended to invest anyway, they will receive a windfall from tax incentives that provides significant motivation for their industry to be included on ‘pioneer’ or ‘priority industry’ lists. Of course, if we accept the argument raised above concerning revenue loss, then the proliferation of incentives only adds to the revenue foregone to the state. Shah (1995) argued that, in any event, the particular features of the business environment in many developing countries lead to incentives being granted to firms that do not need incentives to be enticed to invest. He suggests it is common in developing countries to find that market power is vested in a handful of firms, that a large number of firms have accumulated losses, or some form of credit rationing applies. In any of these cases, incentives will have only a minor influence on stimulating investment from domestic players and in this sense they are wasteful. Finally Brewer and Young (1997) have raised some newer arguments against incentives. They suggest that while countries offer incentives to compete for investment within a particular region such as ASEAN, investment decisions are now being made by firms on a global rather than a regional level. Thus, regional competition for investment is fast becoming

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redundant in the new global sourcing strategies of multinational companies, leading to the conclusion that incentives that single countries design to capture investment destined for a particular region, are losing their pull. These authors argue further that if competition for investment is truly moving to a global level, rich countries will have a significant advantage over poorer ones in this competition. I noted above the argument that incentives can be used as tiebreakers between locations. Rich countries tend to use more direct subsidies to prospective investors whereas developing countries do not have the funds to do this and must rely instead on the less effective mechanism of the tax incentive. The argument from this is that developing countries should have significant motivation for action at a global level for the removal of incentives if they are not to be disadvantaged in the increasingly global nature of competition for investment. Apart from arguments against incentives on the grounds that they are ineffective, there are other compelling reasons for reducing incentives. In Chapter 3 we noted that in developing countries in particular, foreign investment yields maximum benefit to the host country when local firms are able to learn from the technology, management methods and marketing skills of their foreign counterparts. One of the major constraints on this learning process has been identified as the local firms’ inability to learn. It has been demonstrated that the higher the education level of the population at large, the greater the potential for foreign investment to contribute to local industry development. We can therefore argue solidly that the resources currently used for incentive programs may be far more productive if diverted towards local skill development and general education as well as infrastructure. If for whatever reason incentive programs cannot be abandoned altogether, one could argue the case that subsidies for training are most consistent with the development goals that developing countries have for foreign investment. In effect this amounts to reallocating some portion of education costs from the public sector to the private sector. It then becomes a question of which is the more efficient form of expenditure given the different types of education and training that each sector is able to provide. In this respect it is surprising that training incentives are not more prevalent among the developing countries in the East Asian region. Malaysia, Thailand and the Philippines offer some incentives but these are focused fairly narrowly. Yet the more developed countries of Singapore

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and Taiwan recognise the continuing importance of training, with both offering considerable incentives in this area.

The Difficulties in Including Incentives on the APEC Agenda Policymakers in all countries in the region would be well aware of the overwhelming case against the use of incentives. Yet as UNCTAD (1996) notes, all regional organisations have taken almost no action to curtail incentive use since the early 1980s. By way of example, UNCTAD (1996) points out that recent regional investment agreements in both NAFTA and APEC do not address this issue. Similarly, the proposal for speeding up investment liberalisation in the ASEAN group is also silent on the issue of incentives. There is a distinct danger that if no action is taken to reduce incentives, as barriers are reduced and investment environments homogenise, the use of incentives as tiebreakers will escalate even further. The 1994 World Investment Report reported for example, that of the 373 changes in investment rules that they had catalogued between 1991 and 1994, all but five of these were measures aimed at encouraging investment (The Economist 16 December 1995). The failure to include incentive reduction as an objective in regional agreements is not due to a lack of suitable suggestions about how this might be accomplished. UNCTAD (1996) proposes a number of alternatives for including incentives on the international agenda. One is the possibility of expanding the scope of TRIM to include any subsidies that cause injury to producers in another country. If this broad definition was adopted, investment incentives would be subject to WTO oversight. UNCTAD suggests the problem is that for subsidies to be actionable they must be shown to distort trade flows rather than investment flows and accordingly the entire mandate of the WTO would need to be broadened to bring investment within the multilateral regulatory framework. However, Brewer and Young (1997) suggest that the existing agreements on subsidies, countervailing measures and TRIM might be used to challenge some incentive schemes while noting that in the two agreements there are gaps on the issue of incentives. Other alternatives include action at the regional level. Currently the commission of the European Union (EU) has jurisdiction over state aid to industry under the Treaty of Rome and the issue of incentives is being explored under this heading. Other proposals include unilateral action by

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countries to examine their investment incentives, looking particularly at the issues of costs versus benefits, administrative problems relating to the allocation of incentives, possibilities of eliminating some incentives and whether incentives are proliferating. The OECD has in place a non-binding agreement on international investment incentives and disincentives. However, as Brewer and Young (1997) note, the provisions of this agreement concerning consultation on incentives and endeavours to limit their application have been largely ignored. More recently the OECD has moved to establish a Multilateral Agreement on Investment (MAI) which had the potential to include measures on incentive reduction. However, the entire MAI process has faltered due partly to inability to secure agreement among OECD member countries and partly because of the effectiveness of protest action against the MAI by non-govemment organisations. With increasing protest action at many international economic summits, countries are likely to be further constrained in moving towards any form of multilateral agreement on investment in the near future. In any event, Brewer and Young (1997) note that even when the MAI looked possible, the indications were that limitation of investment incentives was not included. Individual authors have also proposed initiatives for incentive reduction. In his article on harmonising investment incentives in the APEC region, Guisinger (1995) proposed that APEC might consider introducing some controls on the level of incentives, raise awareness of the problem of incentive effectiveness, limit the discretion of authorities granting incentives, and the variety of incentives that can be offered. Despite agreement on the need to limit incentives and some quite concrete suggestions on how this might be achieved, incentives continue to escalate and proliferate. Here I present three categories of explanations. The first explains the continuation of incentive measures within the framework of prisoner’s dilemma. The second focuses on the politics of incentives. The third is an institutional explanation. The prisoner’s dilemma rationale is that given competition for investment, countries are reluctant to reduce their incentives out of fear that reducing them will give advantage to their competitors. Thus, even though governments understand the arguments that incentives are ineffective, they are concerned that any reduction would lead to them losing out in tie-breaking decisions by international firms. It has already been shown that countries in the East Asian region in particular watch

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carefully the actions of competitors and are prepared to revise their incentive schemes to keep pace with the competition. The second explanation for the continuation of incentives is a political one. Incentives are very useful political tools for governments to use to maintain their bases of power. The ability of governments to reward particular industries with handouts leads to support for government from those sections of industry that benefit from the handouts. As we have seen, however, the limitations with this strategy are that it is easier to add categories to incentive schemes than to remove them. For Malaysia and Thailand, continuing many of the incentives for various classes of manufacturing activity in while at the same time adding new incentives for high technology companies is a case in point. The danger of incentives from an economic point of view is therefore similar to the traditional arguments against industry policy and protectionism generally: because incentives are a tool for cultivating support, governments will not easily abandon them. A closely related explanation of governments’ reluctance to abandon incentives is tied to the economic development philosophy of the state. I discuss this issue in more detail in the following chapter but here we need to note that many of the East Asian states have a tradition of government intervention to build up sections of industry through an active industry policy. The elaborate plans for promoting selected promising industries to a stage where they become internationally competitive - adopted by governments in Japan, Korea and Taiwan and now followed to a considerable extent by Malaysia, Thailand and the Philippines - require incentives to industry as policy tools. Thus incentives are likely to continue as long as governments of these nations continue to pursue an old style industry policy. I have argued elsewhere (Bishop forthcoming) that with increasing limitations on the bureaucratic and political capacity of states to pursue effective industry policies, we may see a trend towards government replacing industry policy with competition policy. An acceleration of this trend may well provide some optimism for a reduction in incentives provided that the other problems discussed earlier can be resolved. The final constraint on removing incentives comes from within the state itself. In their bids to attract foreign investment, many countries in the East Asian region have developed high profile bureaucratic agencies to deal not only with screening investment but also with granting incentives. These two measures are tied together. While investment agencies may be prepared to gradually reduce barriers to investment because of

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considerable international pressure, it is likely that they will fight to maintain a role for themselves by at least continuing, or expanding, the range of incentive measures they oversee. I have already noted that unlike the situation regarding barriers to investment, on incentive reduction there is a distinct lack of international pressure. In the APEC region it is easier for the more developed countries to push developing countries towards barrier reduction than incentive reduction because the developed countries themselves make considerable use of investment incentives. However, we must also note that continuing incentives also poses a problem for removing barriers because in order to grant incentives, investment agencies may argue that they need to screen some classes of investment. While solutions to this are possible, as Korea has demonstrated, it can be expected that many countries will continue to justify some form of screening on the grounds of determining who is and who is not eligible for incentives. This is particularly the case where wide ranges of incentives are available as in Malaysia, Thailand and the Philippines. Further, countries may state that they have few barriers to investment in the form of screening mechanisms or sectoral restrictions yet through a pervasive incentive scheme are able to effectively monitor investment in any event. For example, Singapore has a wide range of incentives to investors and foreign companies that seek to avail themselves of these incentives if they have already decided to invest in Singapore, which means that most multinational companies come under some form of scrutiny by government agencies. It could therefore be argued that a de facto screening mechanism is in place in Singapore.

Conclusion Competition for foreign investment has led to most APEC countries offering generous incentive packages. Developing countries compete with generous tax holidays and other tax incentives to attract investment in priority manufacturing activities and, in particular, in export oriented manufacturing. The NIEs aim to move up the technology ladder by offering even more generous packages for investment that is classed as high technology investment. As we have seen, Korea, Taiwan and Malaysia have specific lists of industries that fall into this category. The developed countries are even more generous to foreign investors offering outright

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grants for greenfield investment projects that they hope will create jobs and produce spinoffs for local industry. Most economists agree that for the state, the considerable costs of incentive packages do not warrant their economic benefits. I have argued that incentives play only a marginal role in influencing investment decisions and tax holidays in particular are largely ineffective in attracting foreign investment for a number of reasons. First, profits may not anyway be particularly significant during the initial stage of operations when the tax holiday applies. Second, in the absence of tax sparing provisions, tax holidays may amount to a subsidy for taxpayers in the home country of the investor. Third, tax holidays may encourage short-term investment that works against maximising the spinoffs that foreign investment is supposed to bring to the host country. Fourth, tax holidays may distort patterns of investment by encouraging investment that relies on non-depreciable factors of production and on equity rather than debt and in the absence of investment barriers, incentives may have an even greater distorting effect. Fifth, evidence suggests that investors may be wary of overly generous tax holidays that may be unsustainable over the long-term. Finally, it has been argued that the incentive competition is weighted in favour of the developed countries because foreign investors favour their use of direct grants over the tax concessions that developing countries offer. We have seen that developing countries need to upgrade their general skill levels to maximise the spinoffs from foreign investment. If local businesses are incapable of learning from foreign firms, these desired technological spinoffs may be negligible and in extreme cases, foreign investment may actually have negative effects on the economy. This evidence strengthens the case for redirecting the resources used for investment incentives towards enhancing the capability of local firms to learn from their foreign counterparts. Yet there are few initiatives being taken either within APEC or in other international forums to curtail the level of investment incentives. I have argued that this lack of action results from policymakers’ concern that if they reduce their incentives and governments in competing nations do not do likewise, the move will adversely affect levels of foreign investment. More significant is governments’ use of incentives as a tool of industry policy and as a device to gain their own political mileage. Thus political will to engage in meaningful discussion about reducing incentives is lacking. Even with such discussion it is likely there would be strong

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resistance from investment agencies that see incentives as an integral part of their investment promotion strategies. Reducing formal barriers to entry without a complementary reduction in incentives poses serious risks for governments. Incentives are currently seen to play only a minor role in influencing investment decisions, but if barriers to investment are removed, incentives may play a much greater role. Not only will this result in escalating current bidding wars, it may also have distortionary effects on patterns of investment. There is little research currently under way on either the cost of investment incentives or their distortionary effects. If such research were undertaken, it might be possible to use these research findings to convince APEC policymakers that the issue of incentives needs much more weight on the APEC investment agenda.

5 Policies for a Liberalised Investment Environment Introduction This chapter argues that changes in corporate governance practices and the implementation of competition policy are two of the most significant policy changes required for a liberalised investment environment in the APEC region. Trends towards foreign investment in the form of M&As, strategic alliances and joint ventures, along with increased participation by venture capital companies in greenfield investment projects, place corporate governance considerations uppermost in the minds of the newer type of foreign investor. In the absence of corporate governance standards acceptable to these classes of investors, countries and firms within these countries may be disadvantaged in maintaining or increasing foreign investment inflows. Thus improvements in corporate governance may be a more significant incentive to attract foreign investment than the tired old formula of tax concessions. On the other hand, competition policies become more important as investment barriers are wound back. In many countries in the region, the screening processes of investment agencies are able to take into account in the approval process the anti-competitive effects of foreign investment. The liberalisation process involves removing both screening processes and sectoral restrictions. Accordingly, competition policy and agencies that administer it will be needed to ensure that the entry of foreign firms does not result in anti-competitive practices that will counteract the benefits that foreign investment can bring. The chapter begins with corporate governance, examining first how the basic concept applies in various countries in the region and analysing why improvements in corporate governance practices are needed to continue to attract foreign investment flows. I consider the prospects for change in practices in the region and initiatives currently under way in APEC to bring about that change. The chapter then turns to the issue of competition policy, where I discuss both its purpose and importance in a liberalised investment 145

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environment. I explore some difficulties in implementing competition policy in the region and the initiatives APEC has taken in attempting to overcome these difficulties.

Corporate Governance and Corporate Organisation Corporate governance can be defined as the set of relationships between a company’s management, board, shareholders and stakeholders (OECD 1999: 1). Thus we need to consider here issues such as the rights of shareholders to participate in corporate decision making, how decision making is split between the management and the board, how the board itself oversees the day to day management of the company, and the extent to which stakeholders in the corporation should participate or at least be protected. In the APEC region at least three major models of corporate organisation have influenced the pattern of these relationships. These models can be described loosely as the Anglo American model, the Japanese model and the family firm model. The Anglo American model of corporate organisation and governance has been adopted in the US, Canada, Australia, New Zealand, Hong Kong and to a lesser extent Malaysia and Singapore. In the Anglo American tradition, shareholders are regarded as supreme. All company decisions must, in theory, be seen to benefit the shareholder body. Mechanisms exist to allow minority shareholders to be protected to guarantee the widest possible source of funding for corporate activities. In theory, stakeholders - including banks and employees - do not play a major role in determining corporate objectives or in formulating strategies to achieve these objectives. The corporation considers the interests of banks and employees to be less important than the interests of the shareholders, recognising these stakeholders as outsiders whose interests are protected in other ways. For banks, their security over company property and priority in the case of corporate insolvency encourages them to continue to provide finance but on an arm’s length basis. Employees are protected through their contractual relations with the corporation, with some backup from legislation and the ultimate right to enforce both contractual and legislated rights through a court system. It is assumed that decisions taken under the supposed watchful eyes of the owners - the shareholders - will automatically also be in the best interest of stakeholders because the owners have the greatest incentive to ensure that the company remains profitable.

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The continental system of corporate organisation has been more influential than the Anglo American model in some of the major economies in the Asian region including Japan and Korea. In this context we will call it the Japanese model. Japan has adopted the German tradition in which stakeholders play a much larger role than they do in the Anglo American model in governing the corporation. In Japan a pattern of cross ownership developed between banks and corporations enabling banks to play a much greater role in influencing corporate decision making. With the future profitability of banks bound up intimately with that of major industrial conglomerates, there was an incentive for banks to carefully monitor corporate activities. In return the corporation had a ready source of finance. As in the German tradition, employees also played a much greater role in corporate decisions through legally mandated seats on the primary governing body of the corporation. In Japan, a tradition emphasising consensus in decision making processes and the development of a lifetime employment system gave employees even more voice in corporate strategy than their British and American counterparts. Further, the practice of rewarding valuable employees with a seat on the board of directors after retiring from active duties helped to ensure employee interests figured significantly in key decisions. In sum, the Japanese tradition of corporate governance allowed much greater participation by key elements of the corporation, including stakeholders than did the Anglo American model. A third tradition of corporate governance is the family firm model that emerged in corporations in Taiwan and the business entities of the Overseas Chinese in Southeast Asia. In this model, ownership and control were linked closely, primarily through family connections. Families provided the major source of finance for business activities and key employees were also connected. This produced considerable overlap between owners, financiers and employees and often resulted in one key family member exercising control of the corporation. We should note that in earlier stages of Japan’s industrial development too, families played a key role in corporations. This was also the case in Korea and remains so today in many Korean corporations. What has distinguished the Chinese firm has been its reluctance to rely on sources of capital outside the influence of the dominant family members. The Asian financial crisis has triggered unprecedented analysis of corporate governance practices in the East Asian region. Some observers suggest that poor corporate governance practices of corporations were a major cause of the Asian crisis (Waller 2000; APEC 1999a; Wolfensohn

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1998). The weaknesses identified in corporate governance practices include lack of oversight of management by boards of directors, weak accounting standards, insider trading, tight insider control, manipulation of voting, sale of assets without shareholder agreement, extreme anti takeover devices and the use of capital for purposes other than those for which it was raised (APEC 1999a; Brancato 1999). A seminar on corporate governance practices in the region, organised by the Australian APEC Studies Centre (1998), identified the major problems to be over­ concentration of ownership alongside a number of shortfalls - in law and regulation, enforcement, understanding of rights and responsibilities by company directors, participation of outside directors, and transparency, disclosure and reporting to shareholders and stakeholders. The argument tends to be that such practices contributed to companies making the poor decisions that led to corporate financial difficulty and ultimately collapse. In those countries worst affected by the 1997 crisis, companies’ close relationships with banks and in turn the banks’ close relationship with government meant that what could have been a crisis in some parts of the private sector quickly escalated into a crisis of national proportions when external factors put pressure on increasing debt levels. A report to APEC Finance Ministers on corporate governance practices in the APEC region (1999a) not only noted the contribution of poor corporate governance practices to the Asian crisis but also suggested that there was a widening gap between Asia and the rest of the world in this regard. However, we must recognise that there are also weak corporate governance practices in the region’s more developed countries where the dominant model of corporate governance is Anglo American rather than the Japanese or family firm models. Pahn (1998) points to issues such as compensation of chief executive officers (CEOs), the absence of a split between the roles of managing director and CEO, and lack of independence of board members as continuing weaknesses in many corporations in the more developed countries. However, criticism of existing practices alone will not induce practitioners to change their ways. Corporate leaders will need to recognise why improved corporate governance practices will be necessary to maintain and increase investment flows so we will turn here to consider some of the most significant reasons.

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The Rationale for Improving Corporate Governance Two key factors explain the need to improve corporate governance practices in the APEC region as the necessary underpinning for attracting investment flows. First, changes in the form of foreign investment - away from greenfield investment, towards M&As and strategic alliances - places corporate governance practices in host countries under much closer scrutiny. Second, improved corporate governance practices will be required to secure investment from venture capital companies in high technology projects. As we have seen, investment in high tech industries is becoming highly competitive and will become more so as the proportion of overall investment in greenfield projects reduces. Changes in the Form o f Foreign Investment The form of foreign investment is changing significantly. Data indicate that as a percentage of all FDI, M&As, strategic alliances and joint ventures now outrank wholly owned greenfield foreign investment (Hatem 1998). The move towards a global marketplace and competition between firms to secure their market share involves huge corporate commitments of financial and human resources. Because of the extent of this commitment, firms often find it easier to enter into strategic alliances with other firms, or merge directly with or acquire competitors, to augment their capabilities rather than bearing these costs alone. The growing worldwide concentration in the finance, telecommunications, chemical, pharmaceutical, automobile and energy sectors is evidence of this trend (Hatem 1998). Some statistical evidence also supports the trend away from greenfield investment. A survey of the main international investment decisions announced in the worldwide press from November 1996 to October 1997 showed that only 6.45 per cent of those investments were by way of wholly owned greenfield investments. By way of contrast, 37 per cent of those investments were by way of M&A, 12.4 per cent joint ventures and 8 per cent by way of strategic alliances (Hatem 1998: 40). Investment through M&A in the East Asian region has increased from 4 per cent of total FDI flows in 1995 to 16 per cent in 1998 following the Asian crisis and subsequent restructuring in its wake (UNCTAD 1999a: 57). It is expected that this figure will increase markedly in the coming years. In Latin America, some 46 per cent of all FDI in 1998 was through

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M&A (UNCTAD 1999a: 40). This trend is even more evident in the region’s more economically developed countries. In Japan, the increase in inward FDI from $3 billion in 1998 to $14 billion in 1999 was largely through M&As (Fujita 2000). Similarly much of the increase in foreign investment in Korea since the crisis has been through M&A. In the US, M&As accounted for some 90 per cent of FDI in 1997 compared to 62 per cent in 1992 (The Economist 30 January 1999). It may even be that the statistics above understate the extent of M&A within FDI. This is because M&As can take place with no capital movements whatsoever and therefore are not always picked up in FDI statistics. It is possible for a foreign company to acquire or merge with a local company using funds that are borrowed exclusively in the local market and because there is no net inflow of foreign capital, the move is not recorded in FDI data. Foreign investors seeking to form strategic alliances or joint ventures or to undergo mergers are attracted to corporations that exhibit good corporate governance practices. Potential partners that restrict shareholder participation, do not adequately protect shareholder rights or are weak on disclosure of company performance to shareholders will inevitably be less attractive to major international companies that regard good governance practices as fundamental to their own operations. Foreign investors seeking strategic alliances or joint venture partners to globalise their business will turn to partners elsewhere with corporate conduct more similar to their own. Attracting High Technology Investment The second reason for needing to have good corporate governance practices is bound up with the desire of countries in the APEC region to attract high technology investment. Discussion in the previous chapter of investment incentives showed the extent to which countries are prepared to go to attract this type of investment. Much of the investment in high technology projects requires funding from venture capital companies that receive a stake in the equity of the firm to secure their financial contribution. For this reason venture capital companies will look increasingly to the firm’s corporate governance practices before advancing finance. Thus, to secure investment in high technology areas, it will be important for local companies to demonstrate that they are pursuing best practice in the field. Firms operating in countries where state of the art

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corporate governance practices form the basis for regulation of corporate behaviour may be better placed to compete for the limited supply of venture capital. Some evidence already substantiates the importance of venture capital companies in high technology industries. In the US, venture capital companies have been described as the driving force of the new economy (Vere Nicholl 2000). The need for a venture capital industry in the East Asian region is clear. China, for example, is unable to commercialise many of its technological achievements due to lack of funds (Yao 2000). In China, venture capital companies provide only 2.3 per cent of the funding for commercialisation whereas in the US some 50 per cent of technical advances are capitalised through venture capital companies. China is currently considering amending regulations to allow foreign venture capital firms to establish inside China. However as Vere Nicholl (2000) points out, straightforward and reliable corporate governance practices are vital for a dynamic venture capital industry to emerge in any economy. Hsu (2000) also makes this point. He argues that venture capital companies are responsible to those providing the funds and because these companies have high accountability they insist on high standards of accountability in the corporations in which they invest. Hsu notes that in Taiwan, the need to acquire high technology is driving changes in the corporate governance practices of Taiwanese companies.

Pressures for Changing Corporate Governance Practices To what extent are corporate governance practices changing in response to this need and who or what is driving these changes? I argue here that institutional investors, listing authorities, accounting bodies, regulators and financial institutions are all likely to play their part in improving corporate governance practices in the region. The most significant pressure for change is likely to come from shareholder groups, in particular US institutional investors. Brancato (1999) has noted that of the total financial assets of institutional investors in France, Germany, Britain, the US and Japan, 62 per cent of these belong to US institutions. It is therefore likely that corporations in the APEC region seeking additional capital will have to deal with US institutional investors and other outside investors as shareholders. A trend in this direction is already evident with purchase of emerging market equity by

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US investors almost doubling to $23 billion in 1998 from only $12.5 billion in 1997 (Brancato 1999). In all likelihood US and other institutional investors will seek to influence corporate governance practices in the companies in which they invest (Pahn 1998). Alternatively, these investors may invest only in companies that they perceive to exhibit good governance practices. This will pressure companies seeking capital to look closely at their own practices. However, it is not only foreign institutional investors who may insist on changes in corporate governance; domestic investors may also bring this pressure to bear. For example, Japanese pension funds and life insurance companies are increasing pressure on Japanese corporations for better returns and better corporate governance practices (Weinberg 1997). Philip Pahn (1998) has noted an upsurge in shareholder activism in countries such as Britain, Canada, the US and Australia through the 1990s and argues this is likely to spill over to Asia. While it could be argued that cultural barriers in some APEC countries impede shareholders challenging corporate decision making processes, this situation is beginning to change. In Korea, shareholders have successfully taken action against the Directors of Korea First bank for negligence and have obtained a significant damages award (Sargeant 1998). Shareholders of SK Telecom have forced management to agree to the appointment of outside directors to guard against mismanagement (Dubiel 1999). We also find examples elsewhere in the region of companies taking greater account of shareholder interests. For example, Forbes Magazine found it sufficiently noteworthy to report that one Japanese corporation was even prepared to hold its shareholder meeting on a Sunday to suit shareholders’ convenience (Weinberg 1997). Under these circumstances we have strong reason to argue that competition for investment funds, increasing shareholder activism and the proliferation of codes of good governance will impose increasing pressures on corporations in the APEC region to review their governance practices. There is also pressure upon national governments to improve their regulatory framework and institutional support in national contexts to ensure that corporations adopt good corporate governance practices. The recommendations of the recent report to APEC Finance Ministers (1999) are particularly telling in this regard. This report puts forward a range of legal reforms that member economies should consider. The reforms include strengthening company laws to protect minority shareholders, particularly in relation to their rights to participate in meetings; requirements that company directors disclose

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related party transactions; empowering shareholders to elect representatives to the company board; requirements to have independent non-executive members on the board; establishing board committees especially on remuneration, audit and nomination of directors and officers; specifying directors’ duties in greater detail in legislation, and giving power under law to regulators to impose penalties for breach of these duties; ensuring that there are well resourced regulatory agencies; adopting internationally accepted accounting standards and overseeing adherence to these standards (APEC 1999). APEC Finance Ministers have accepted these recommendations and have requested member economies to report voluntarily at APEC Finance Ministers Meetings on what an action that is being taken (APEC Finance Ministers Meeting 1999). This is not to say that regulatory change has been absent from the region. In the US, for example, there have been moves in recent years to strengthen the legal rights of stakeholders following the perception that US companies have tended to give overwhelming priority to shareholder rights as opposed to the rights of stakeholders (Pahn 1998). By contrast, the IMF has insisted on regulatory changes in Korea to strengthen shareholders’ interests as against stakeholders’ interests. These measures include easing the requirements for shareholders to bring derivative litigation and the requirement to have 25 per cent of corporate board membership other than the company’s directors (Ehrlich and Lee 1998). While there are pressures for regulatory change to support a new framework of corporate governance in the region, it is important to note as Adrian Cadbury (World Bank 1999) has, that regulatory change of itself is unlikely to lead to better corporate governance. It can be argued that the effectiveness of any legal regime depends in large part upon society’s willingness to comply with this legal regime. Enforcement activities alone are unlikely to bring about the change in corporate behaviour that international circumstances now encourage. A precursor to effective regulatory enforcement entails significant institutional development in many countries. Without this institutional development some countries may not have the capacity to monitor corporate compliance with legislative changes. Regulatory pressures for change in corporate governance are therefore likely to be effective in the longer term rather than in the shorter term when institutional arrangements are insufficient.

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It is also likely that financial institutions will come to play a much larger role that at present in pushing for good corporate governance practices in corporations to which these institutions give loans. Financial institutions have long played a significant role in corporate governance in Japan. Not only have Japanese financial institutions been a major lender to Japanese companies but they have also often been major shareholders and suppliers of information and management personnel to these companies (Jones and Tsuru 1997). In this way the financial institutions have been able to monitor the performance of corporations and take action if they recognise corporate performance as unsatisfactory. However, as liberalisation of financial systems proceeds, banks in Japan and in other countries where they have played a direct role in corporate governance, will have less direct influence as corporations diversify their funding sources. In response banks may adopt a more indirect approach to protecting their investments by ensuring that their debtors have sound corporate governance practices in place. An additional factor that might lead to sounder corporate governance is the adoption of good governance practices by banks themselves. There is some evidence that this is already occurring in Singapore where banks are being pressured by government to adopt better corporate governance practices. This is partly a result of the Asian financial crisis and partly because this move is seen as necessary in Singapore’s push to become a major regional financial centre. It is probable that other countries in the region will follow suit as their financial systems are restructured, thereby leading to banks themselves becoming a major source of pressure for changing corporate governance practices. In recent years, listing authorities in some OECD countries have taken an activist role in pushing for higher corporate governance. For example, following the lead of the London and New York stock exchanges, both the Toronto and Sydney stock exchanges now require that companies that seek to be listed demonstrate their conformity with the corporate governance standards of the exchanges. More recently, the Tokyo Stock Exchange has insisted that all companies disclose their efforts to improve corporate governance in the annual returns they must file (The Economist 1 May 1999). In 1998, the Singapore stock exchange issued a best practice guide that also requires each listed corporation to state in its annual report how it has complied with this guide (International Financial Law Review 1998).

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It seems likely that best practice guides will become more prevalent throughout the APEC region, leading to further pressure for public corporations to look carefully at their corporate governance practices. The report to APEC Finance Ministers specifically recommends that ‘banks, institutional investors, asset managers and other financial intermediaries explicitly scrutinise corporate governance as part of the investment criteria and decisions’ (APEC 1999a: 24). The adoption of internationally accepted accounting standards lies at the heart of good governance practices. Without sound accounting principles, boards of directors, shareholders and other stakeholders simply do not have sufficient information to evaluate company performance. On the other hand, as accounting standards improve, information will become available to shareholders and stakeholders enabling them to insist on better corporate governance. The recent OECD principles (1999) strongly recommend the adoption of high standards of accounting and auditing practice. The report to APEC Finance Ministers also recommends the ‘rapid adoption of high quality, internationally acceptable accounting standards... and the rigorous oversight of these’ (APEC 1999a: 22-3). In endorsing the Report’s recommendations, APEC Finance Ministers said: We urge member economies to strengthen, where relevant, the quality of existing auditing and accounting standards, and move towards the adoption of practices that meet or exceed international standards. In this regard we welcome the work of the International Accounting Standards Committee to develop a full range of accounting standards which could facilitate informed decision by the investing public by promoting full, fair and complete financial reporting (APEC Finance Ministers Meeting 1999: 4).

There is evidence that countries in the region are moving towards international accounting standards. For example both China (Broadman 1999) and Korea (Ehrlich and Lee 1998) have recently moved to align their accounting standards more closely with international norms. A recent World Bank study has noted that several countries in the East Asian region including Malaysia and Thailand have made strong efforts during the 1990s to improve accounting and reporting standards (Alba, Claessens and Djankov 1998). These authors add, however, that there is still room for further improvement. This improvement will depend to a large extent on

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strengthening the accounting profession throughout the region as noted in the 1999 report to APEC Finance Ministers. The discussion above has set out a number of factors that are likely to pressure corporations to look more closely at their corporate governance practices. However, even in the face of these pressures, some corporations will be reluctant to change their governance practices as the following section makes clear.

Towards Uniformity in Corporate Governance Practices in the APEC Region Here we address the issue of whether the need for change and the sources of pressure that are beginning to induce this change will lead to the adoption of a uniform set of practices in the region. There is currently no Code of Corporate Governance for the APEC region. However, in 1999 the OECD adopted a set of corporate governance principles for use in OECD member countries. It is worthwhile examining whether these principles might be able to be adopted in the APEC region. The OECD principles are divided into five major sections. The first section is entitled ‘the rights of shareholders’. Under this heading the OECD guidelines suggest the need to protect the basic property rights of shareholders including being able to register and transfer their shares, participate and vote at shareholder meetings, elect members of the board and share in the profits of the corporation. The rights of shareholders also include the right to participate in important decisions of the company such as amendments to the company’s articles of association or transactions that result in the sale of the company. The section also states ‘a degree of control disproportionate to their equity ownership should be disclosed’ (OECD 1999: 5). The second section of the guidelines focuses on the equitable treatment of shareholders. In particular the guidelines point to the need to prohibit insider trading, to require boards and managers to disclose any ‘material interest’ in transactions that affect the corporation, and to ensure that all shareholders of the same class should be treated equally and be given the means to exercise their voting rights. The guidelines’ third section deals with the rights of stakeholders. It states simply that the corporate governance framework should ensure that the legal rights of stakeholders are protected, that stakeholders should have

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effective means to obtain redress if their rights are violated, that they should be provided with adequate information about the corporation and finally that ‘the corporate governance framework should permit performance enhancing mechanisms for stakeholder participation’ (OECD 1999: 7). The fourth section of the guideline’s deals with disclosure and transparency. In particular it states that corporations should be required to disclose material information on financial matters, company objectives, major share ownership, members of the board and their remuneration and governance structures and policies. The principles point to the need for ‘high quality standards in accounting, financial disclosure and auditing’. The fifth and final section of the guidelines deals with the responsibilities of the board of directors. This section starts by imposing on the board the traditional fiduciary principles of acting in good faith, with due care and diligence and in the best interests of the company. It enumerates some of the key functions of the board including review and guidance of corporate strategy, selecting and monitoring key executives, reviewing executive and board remuneration, ensuring integrity of accounting and financial reporting systems, monitoring governance practices and overseeing disclosure processes. Some observers have noted that boards should in fact have subcommittees to deal with each of these areas (Pahn 1998). Others use the existence of subcommittees in some of these areas as indicators of good governance (Davis 1999). This section of the principles also notes the need for boards to be able to exercise judgement independently of management. The principles state that corporations should consider having a number of non-executive directors to ensure board independence. The principles also note that the board is responsible for managing conflicts of interest within the corporation generally or within the board itself. Some might suggest that there is some inconsistency in the principles here in that the more outside directors there are, the more likely it is that conflicts and tensions will arise. It is clear that the OECD principles on corporate governance tend to favour the Anglo American model of corporate organisation. The recommendations of the report to APEC Finance Ministers also appear to be premised on an Anglo American form of corporate organisation. The attention to the rights of shareholders and organisation of boards of directors tends to assume widely dispersed ownership. It may well be the case that many corporations in the East Asian region will inevitably evolve

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into much more widely held entities and that consequent pressures from institutional investors, accounting bodies and listing authorities will lead to greater convergence in the form of corporate organisation and wider acceptance of common corporate governance principles. However, at present, there is still a significant degree of concentration of ownership in corporations in the East Asian region. A World Bank study has identified that of some 3,000 publicly listed corporations in the region, over 50 per cent can be considered to be family controlled (Claessens, Djankov and Lang 1998). Figures vary from country to country as we see in Table 5.1 that shows the percentage of companies in East and Southeast Asia of which members of a particular family control 20 per cent of the shares. Based on other studies, the 20 per cent level is considered to indicate sufficient shareholding to be regarded as a controlling shareholder particularly if there is no other single shareholder who owns more than 10 per cent. The study suggests that there is an 80 per cent probability of this in the 3,000 corporations sampled.

Table 5.1: Corporations in East and Southeast Asia with 20 per cent Family Control (unit:

%)

Hong Kong Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand

66.7 71.5 9.7 48.4 67.2 44.6 55.4 48.2 61.6

Source: Claessens, Djankov and Lang (1998: 30).

The study showed further that older companies are no less likely than newer companies to be family controlled. This leads to the conclusion that family control of corporations in East and Southeast Asia is an ingrained feature of business enterprises in the region. It is at least arguable that the tight control that families have held over their business enterprises has been partly responsible for the success of those enterprises. A number of studies have shown that concentration of

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ownership can enhance corporate performance (Schleifer and Viskny 1997). If this is correct, then family owned or controlled firms are likely to resist adopting corporate governance principles that these firms see as a threat to continuing family control. Adopting principles such as separating the roles of the CEO and Chairman of the board, the presence of outside directors, the ability of shareholders to appoint directors and the committee system may all be seen as weakening otherwise successful corporations. This resolve may be even stronger in corporations that have come through the Asian crisis relatively unscathed. They may well argue that it was tight family control that enabled them to survive externally induced instability. It might also be argued that mechanisms are already in place to control inefficient corporate management. Market based methods of control include the possibility of takeover (subject to devices in a company’s articles of association making this difficult). The threat of takeover is often cited as a significant incentive for boards of directors to ensure that the company performs. Institutional mechanisms of control include the monitoring of companies’ operations by financial institutions and other companies that have significant cross shareholdings. In Japanese keiretsu, when a company in the group begins to encounter financial difficulty, corporations with cross shareholdings are the first to attempt to correct the situation. As the second wave of defence, the financial institution financing the group exercises its powers as shareholder to force change (Kim and Limpaphayom 1998). Thus many who defend their present arrangements in whichever national context will argue that market based and institutional based methods of monitoring corporate performance already function as sufficient mechanisms to keep corporate governance practices in check. Further, given the prominent role that stakeholders (including banks, employees and the state) tend to play in corporations in many countries in the APEC region, the section of the OECD principles on stakeholder rights could be regarded as brief. Again, the principles tend to assume a position close to the Anglo American model where the entities traditionally regarded as ‘stakeholders’ are much more at arms-length from the corporation than is the dominant corporate practice in many parts of Asia, for example. Wide acceptance of the OECD principles in the East Asian region in the short-term may thus be very optimistic. Some observers have noted that changes in corporate governance practice is a long-term process (Iskander, Meijanen, Grey 1999). This recognition helps to explain attempts currently under way to formulate more broadly based principles that can be adapted

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to the various forms of corporate organisation in the region. It has been suggested that the basic principles underlying good corporate governance practices include transparency, accountability, fairness and responsibility (World Bank 1999). As I note below, this is the approach that has been taken in relation to competition laws in the region.

The Purpose of Competition Policy Economies in the region that have specific competition policies have several related goals in mind. Competition policy aims to ensure that there is sufficient competition in the market so that goods and services are available at the lowest cost to consumers. A closely related aim is to ensure equality of market entry to all possible providers of those goods and services. This implies minimal interference by government in the marketplace resulting in lower costs of government administration and reduced inefficiencies caused by the misallocation of resources through rent seeking. The laws giving effect to competition policy typically seek to control anti-competitive behaviour caused by individual firms and by collusion between firms (Wood 1995). The potential for anti-competitive behaviour at the level of the individual firm arises when a firm obtains dominance in the marketplace and abuses this position. Abuse of dominance includes such practices as preventing other competitors from entering the industry through pricing strategies, refusing to deal with certain suppliers or customers, refusing to allow others access to infrastructure provided by the firm and tying customers or suppliers into multi-purchasing agreements. Anti-competitive behaviour through collusion between firms includes such practices as cartels, exclusive dealing arrangements and fixing price or market share. In both cases, difficulties arise in determining whether anti-competitive behaviour exists in the market and then whether or not such anti­ competitive behaviour works against the goals of competition policy. These difficulties of judgement may be more acute in determined cases of abuse of dominant position, as Wood (1995) points out. This is because firms achieve dominance in the marketplace by being more successful than their competitors and to punish such success could appear to be contrary to the goals of a free market economy. Thus competition laws focus on the abuse of dominance rather than dominance itself. Yet even here enforcing

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competition policies may be difficult because what might appear to be abuse of a dominant position may be the outcome of monopoly rights given to a corporation by the state. The transport, telecommunications and utilities industries offer ready examples. As to collusive arrangements, other difficult choices need to be made between competition policy goals and other goals. For example, intellectual property rights are often accompanied by the right to grant exclusive licences to use that intellectual property. However such exclusive licences appear to run counter to competition policy. In these circumstances there has to be some trade off between providing sufficient incentive for innovation on the one hand and pursuing the goals of competition policy on the other. Here we have noted some of the difficulties in administering competition policy. Yet there are compelling reasons for paying greater attention to competition policy in the APEC region’s increasingly liberalised investment environment.

The Rationale for Competition Policy in a Liberalised Environment Earlier in this book we have considered the significant liberalisation in many APEC economies over the past decade through reduction in screening mechanisms and opening market sectors to foreign firms. If the formidable political difficulties in all economies and the economic concerns of developing countries can be overcome, then further liberalisation is likely to be seen as APEC marches towards its Bogor targets of full liberalisation in the region by 2020. There are two seemingly conflicting reasons why the adoption of competition policy is necessary in a liberalised investment environment. For investors, removing formal entry barriers is only a first step towards a truly liberalised environment since behind these formal entry barriers lies a range of operational restrictions, regulations and business practices that affect the every day business environment. Some of these serve to advantage local firms over newer foreign entrants in all economies. In the US, there have been complaints that state regulations favour local power companies over foreign competitors. In Japan, entrenched networks between manufacturers, distributors and retailers can make entry difficult for a foreign firm. In China, decades of central planning and the attendant privileges that it bestowed on state-owned enterprises artificially advantage these domestic entities over foreign investors in many industries. Thus

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investors argue that a truly liberalised investment environment requires a level playing field not only in market entry but also in equality of operating conditions. Investors argue that a competition policy that functions properly would begin to erode the advantages that locals have since it would reform practices and regulations that either establish local firms in dominant positions in a market or quietly sanction collusive behaviour. As will be seen, such hopes for competition policy in the APEC region may be optimistic at this stage. The second argument for competition policy comes from the perspective of host countries themselves. As we saw earlier, foreign investment can provide a competitive spur to local firms or it can outcompete local firms and drive them out of business altogether. Sjoholm’s (1999) study of Indonesia shows how the impact of foreign investment can vary greatly depending upon whether one views it at the national level or the regional level and from an inter or intra industry perspective. It appears that the potential for foreign firms to have a negative impact on the host country is much greater when the host country does not have an adequate competition policy. If there are no restrictions on strategies such as predatory pricing, incoming foreign firms with significant resources can eliminate any local competition with relative ease. Likewise, collusive arrangements between foreign firms and locally based foreign suppliers could rapidly undermine the many advantages that host states hope to gain from developing a local supplier industry. It could be argued that the approval mechanism currently in place in many developing countries enables efficient investment authorities to either screen out foreign investment that is likely to have adverse competitive consequences for local industries or to impose conditions that will prevent this adverse outcome. However, in the absence of a working competition policy and bureaucratic agency to implement it, removing the screening process leaves no monitoring mechanism other than the marketplace. While there has been debate concerning the extent to which competition matters should be left to the market rather than to yet more regulation and another bureaucratic agency, it is well known that in developing economies in particular markets will not necessarily work to correct for anti-competitive conduct. Thus, it is most appropriate to begin to implement a working competition policy as formal entry barriers are wound down. Failure to do so may result in more cases of foreign firms engaging in anti-competitive behaviour that further retards the liberalisation process.

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The convergence of interests on this issue between investors and host states, albeit for different reasons, suggests that formulating and implementing a suitable competition policy should be relatively easy. Yet as the following section makes clear, formidable challenges remain.

Difficulties with Implementing Competition Policy in the APEC Region There are two major stumbling blocks on the path towards functional competition policies in the APEC region. The first is bound up with underlying philosophical differences in the region concerning the role of the state in economic activity. The second obstacle flows from this. Various institutions have been developed to fit within this basic philosophical framework. A workable competition policy will require not only a change in philosophical orientation in many countries in the region but also significant institutional change. These arguments are explored in more detail below. In the East Asian states and to a lesser extent in the Latin American APEC member nations, there has been a tradition of considerable state intervention in the economy pursued via an active industry policy. Their approaches to foreign investment illustrate this well. Japan and Korea severely limited foreign investment until recent years, allowing it only in cases where bureaucrats considered that it could play a significant role in building local industry. In Korea, foreign investment was encouraged only in EOIs and a few key strategic industries until the early 1980s. Once Korean firms became more competitive, foreign investors were allowed to establish in all manufacturing activities whether export oriented or not, although opening the service sector to foreign competition did not begin until the early 1990s (Bishop 1997). In the major Southeast Asian states and to a lesser extent in Taiwan, bureaucrats still attempt to steer foreign investment into sectors of the economy that are considered top priority for economic development. In earlier chapters I have discussed the detailed screening requirements, sectoral restrictions and incentive programs that seek to accomplish this aim. Some argue that in China, industry policy is still the major determinant of foreign investment policies (Rosen 1999). In contrast, however, the Latin American countries have abandoned detailed industry policies over the past two decades, although the state still intervenes in several key sectors.

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There are many competing explanations of why industry policy has figured so prominently in the economic development strategies of East Asian states. However, all tend to rest on the premise that key policymakers believed that the development of vibrant firms and industries could not be left to market forces alone; the state needed to play a guiding role in providing finance and determining industrial development priorities as well as in the more basic matters such as infrastructure and education. Some argue that this view was consistent with a tradition in East Asia of a paternalistic state. Others argue that the state intervened in economic activity to prevent any challenge from a newly emergent business class to the power bases of authoritarian rulers. Still others claim that the competitive adversarial nature of a market based economic system did not sit well with traditional Asian cultural values of harmony and consensus (Rosenbaum and Matsushita 1995). Our concern here is whether the interventionist view of policymakers that drove economic policy through these economies’ intense industrial development still holds, or whether there is now an inevitable trend towards market dominated economies. Those who argue this trend is under way point to the gradual retreat of the state from economic activities as evident in privatisation, deregulation and a gradual but perceptible move towards liberalisation in trade and investment. A propellant to this trend may be increasing démocratisation in East Asia accompanied by a rise in interest group activities with cross cutting demands on policymakers who will have to compromise to maintain their power, making it difficult to run a cohesive and consistent industry policy. Those who argue that industry policy remains as active as ever could well use foreign investment policy as evidence. They could also argue that the privatisation and deregulation now under way is only at a superficial level, leaving intact the basic institutional features that have been the mainstay of industry policy over many decades. Policymakers in many of the East Asian states may be divided on the extent to which state intervention should be wound back. Some in government and in key parts of the bureaucracy are attempting to steer the economy away from state intervention. Others are resisting this push. A simple attempt to categorise supporters and detractors of the free market position would identify the players’ self-interest. But there may be deeper causes as well. Opinion may be divided even within ministries, depending upon the beliefs of particular individuals favouring state intervention or a market-oriented economy. It is difficult to see a dominant view in many

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countries in the region outside the more developed nations of the US, Canada, Australia and New Zealand, with Chile being the only clear example of a developing country with a reasonably entrenched free market philosophy. We have dealt with this issue in some depth here because the fundamentals of competition rely upon a free market approach. The goals of competition policy assume a minimalist role for the state, freedom of entry and exit for firms, and the allocation of resources according to market demand. These conditions are diametrically opposed to an industry policy approach where the state plays a key role, monitors exit and entry of firms, and influences the allocation of resources according to development priorities. Thus a workable competition policy in many countries in the APEC region will require a more significant shift towards a market economy than has been seen to date in many countries in the region. The second set of difficulties flows from the first. Even if a consensus is achieved that a move towards a market based economy is desirable, significant institutional change will be required to bring that about. This will be difficult because institutions in the East Asian nations have developed around the state interventionist model, as the role of investment agencies illustrates. We have noted that in the East Asian states investment agencies have played a key role in screening foreign investment to determine whether the investment should be allowed and if so on what terms. Investment agencies have developed into formidable bodies and in many cases are amongst the most efficient arms of the bureaucracy. They are staffed with some of the most talented people available in the public sector. Further they have been given priority in many countries through attachment to either high profile ministries such as the Ministry of Trade and Industry (Malaysia, Korea and the Philippines), or directly to the office of the President (Indonesia) or the Prime Minister (Thailand). Taiwan and China attach investment agencies to the powerful Ministry of Economic Affairs and Ministry of Foreign Trade and Economic Cooperation respectively. Within the Ministries to which they are attached, investment agencies have assumed a special position. This is partly because of the skilful arguments put by agencies that they need to be in a special position to adequately meet the needs of foreign investors since they have to coordinate across ministries. The creation of one-stop shops for foreign investment in many countries in the region could be due not only to foreign investors’ requests but also to the desire of investment agencies to enhance

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their profile and power within the bureaucratic hierarchy. To maintain this position, however, these agencies must demonstrate that they are effective. The competition for investment among countries in the region has played a significant role in ensuring that investment agencies in particular countries remain efficient and effective. Investment agencies face a considerable threat to their position as liberalisation gathers momentum. As investment barriers are removed, the overall standing of investment agencies will fall. With reduced ability to screen investment and the increasing number of industries where national treatment is given, agencies will have less scope to influence investment patterns. In the absence of special barriers to foreign investment, the ministries that handle licensing procedures for domestic investors will be able to deal with necessary arrangements. Investment agencies therefore face the twin fears of all bureaucrats - restructuring and downsizing. Thus arguments concerning the need to reduce investment incentives will receive little sympathy from investment agencies since providing incentives to investors is one of their last ways to retain influence. A solution here is to transform investment agencies into investment promotion authorities as has been accomplished successfully in Canada and Korea. Elevating competition policy to an area of special concern will pose an even greater threat to the traditional role of investment agencies than removing investment barriers. Mounting a successful competition policy requires an agency that monitors and enforces potential abuse of dominant position and collusive agreements. In the US, competition authorities face formidable coordination tasks across the bureaucracy (APEC 1999b) and sometimes find themselves competing with the regulatory scope of other agencies (Waller 1996: 1122-5). If competition policy is a main aim of economic policy, competition agencies need to be well resourced and have a high profile within the bureaucracy. Caceras (1998) has pointed out the problems of relatively new competition agencies, especially in obtaining political support for their activities that are often inadequately resourced and without sufficient power to enforce their findings, and with other agencies over who has discretion. The relationship between competition agencies and investment authorities is likely to be difficult. Investment agencies have traditionally played the major role in monitoring foreign investment. In a liberalised investment environment, this role will shift primarily to competition authorities, requiring some transfer of power and status from the

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investment agencies to competition authorities. This is a significant transfer of power within the bureaucracy and hence will take time to effect. Competition agencies will also face problems while significant elements within government and bureaucracy continue to favour maintaining state intervention in economic affairs through old style industry policy rather then pursuing the newer style of regulation embodied in competition policy. The move towards an economic policy that emphasises the market as the primary determinant of economic activity, with the state in a diminishing role, will result in major economic restructuring within countries involving loss of jobs and business in older uncompetitive industries (Jenny 1995; APEC 1999b). Without adequate social safety nets to help mange this transition, a major upswing in popular resentment is likely against free market economy ideals and, by association, against the agencies of the state that seek to implement these ideals. The protest movement against globalisation is gathering force in many countries as a voice for those who are affected adversely by the changes in economic structure brought about by a more liberalised international economic environment. Politicians face formidable tasks in managing this restructuring process if it is not to be derailed completely. Because politicians seek to appease voters to maintain their power, even at the highest political levels we are likely to see significant opposition to giving very much power to competition authorities. This resistance from various sources will help to maintain the status quo and the high profile role of investment agencies. Even if competition agencies are adequately resourced and are given a high profile within the bureaucratic apparatus, they will face significant problems in implementing their policies successfully. Even in countries with a long experience in competition policy, opinions differ on what constitutes an abuse of dominant position and whether collusive behaviour necessarily reduces welfare (Jenny 1995). Some observers claim that implementing competition laws following the Anglo American model would require completely reorienting the basics of economic activity in many countries and for this reason competition policies need to be cast in general terms rather than in specifics (Wu and Waverman 1995).

168 Liberalising Foreign Direct Investment Policies in the APEC Region APEC and Competition Policy Despite these philosophical and institutional constraints, a consensus is emerging in the APEC region on member economies adopting competition policies. Early tentative steps towards this goal were taken by the EPG appointed by member economies to advise on APEC’s future direction. The Group’s 1993 report recommended strengthening competition policies in the region as a necessary accompaniment to trade and investment liberalisation. Other parts of the APEC hierarchy accepted this view and in 1994, APEC’s Committee on Trade and Investment was mandated to establish a working party on competition policy to develop an understanding of competition policies among member economies. The working party has held several workshops on competition policy and has developed a database of the competition policies and laws of all those member economies that have them. In 1996, to recognise deregulation and competition policy as complementary policy measures, APEC merged the deregulation and competition working groups. The Asian crisis added impetus to the work of this committee and in 1999, the PECC used its official status in APEC processes to put forward a set of competition principles for member economies to consider. These principles were subsequently endorsed at the formal APEC meetings held in Auckland in September 1999. The PECC competition principles (PECC 1999) are an important milestone in building understanding of competition policy in the region. The principles endorse the notion that competition policy is central to enhancing economic efficiency and is necessary to accompany trade and investment liberalisation. Rather than specifying what competition policy should be, the PECC competition principles set out broad underlying principles on which can be based more detailed laws concerning abuse of market dominance, restrictive business practices, unfair competition and other matters. One reason for adopting general principles rather than the specific details of competition is to accommodate the different views of APEC members about what amounts to abuse of dominance or restrictive business practices (Rosenthal and Matsushita 1995). The four core principles set out in the PECC report are comprehensiveness, transparency, accountability and non-discrimination. Comprehensiveness refers to the need for competition policies to apply to all goods and services. Transparency means that the policies and laws based upon these policies should be clear and implemented consistently.

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Those who devise and implement the laws should be held accountable for the operation of these laws and apply them in a non-discriminatory manner between domestic and internationally sourced good and services. It is immediately apparent that the principles enunciated above are diametrically opposed to those upon which industry policies have been based. Industry policy has frequently been selective rather than comprehensive, and its operations opaque for those outside the narrow confines of the network of business-government relationships in any particular industry. Those who implemented the old industry policies had significant discretion and frequently were not held accountable either to an elected government or to any form of administrative review. The old industry policies were often designed deliberately to be discriminatory in order to protect local industries from foreign competition until those industries could compete in the international marketplace. Thus even though APEC competition principles appear to be designed to be broad enough to allow scope for variation in national laws, the assumptions behind them are clearly oriented towards a market based economy rather than one in which a key role for the state is assumed. In order to gain wide acceptance of these principles the APEC process will need to work at a deeper level in promoting a shift toward a market oriented philosophy. It is likely that such a transition will take time. It is therefore useful that work has begun now if the Bogor goals are to be achieved.

Conclusion Improvements in corporate governance practices and a workable competition policy are two important priorities for a liberalised investment environment in the APEC region. Corporate governance practices in the region derive from three primary sources: an Anglo American tradition, a continental European tradition and a tradition of family owned firms. Despite the differences in models of corporate organisation, pressure from a diverse range of sources now challenges past practices of governing corporations. Regulators, banks, listing authorities and institutional investors require boards of directors to be more accountable for both the internal management of the company and its relationship with shareholders and stakeholders. The OECD has proposed a set of principles to guide corporations on enhancing accountability. These OECD principles have

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been mirrored in a report to APEC Finance Ministers on corporate governance practices in the region. An important reason to continue improving corporate governance practices is that this improvement is necessary to maintain and increase investment flows. M&As, joint ventures and strategic alliances are becoming more significant than greenfield projects in overall investment flows and investors in these newer types of investment place the corporate governance practices of firms under greater scrutiny. With greenfield investment, all countries keenly seek projects that embody high technology and venture capital companies are increasingly funding these projects. Even so, venture capital companies are unlikely to make funds available if corporate governance practices do not meet acceptable standards. Governments will find it difficult to implement both the OECD principles and the recommendations of the APEC report on corporate governance because these principles tend to assume that the Anglo American form of corporate organisation is the norm. As we have seen, this form of corporate organisation is not the dominant form in many parts of East Asia. Thus, the principles of corporate governance will need to be crafted more broadly to accommodate differences in corporate organisation, or corporate organisation will need to change so that corporate governance can be improved. Because changing the form of corporate organisation may be an evolutionary process, attempts are under way to adapt existing codes of corporate governance to suit existing styles of corporate organisation. It is still early days here and it remains to be seen what results these adaptation attempts will achieve. On the other hand, proposals to adopt competition policy have advanced significantly since APEC endorsed a broadly based set of competition principles. As formal barriers to foreign investment fall, competition policies will be necessary to ensure that operational barriers are not used to favour local firms over their foreign counterparts. If competition policies are not in place, it is easier for governments to advantage local firms over foreign firms and the competitive spur that foreign investment can provide to local industry may not take place. Alternatively, in developing countries in particular, the absence of a competition policy may result in foreign firms being able to secure and abuse positions of dominance in the market. As with corporate governance, implementing competition policy poses difficulties for some countries in the region. There are two key reasons. First, competition policy assumes a free market system with entry and exit of firms and prices determined in the marketplace. Yet in many parts of

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East Asia detailed industry policies give the state, rather than the market, the primary role in deciding industry structure. Thus, competition policy will be difficult to implement as long as old style industry policy still takes effect. Second, competition policies will require institutional change. Industry policy has given considerable power to key agencies of the state including investment agencies. Restructuring the institutions of the state to give more power to competition authorities will not be an easy task we have seen already, even in APEC countries where working competition policies have been in place for many years. Nonetheless, the APEC competition principles are an important first step on the road to replacing formal entry barriers to investment with competition policies.

Conclusion The APEC process has adopted trade and investment liberalisation, trade and investment facilitation and economic cooperation as its three major objectives. Since its inception, there has been a persistent line of criticism that little progress is being made towards these goals. As we have seen, the business community is the most vocal of those critics. These views are echoed from time to time in the popular press and in specialist economic and business periodicals. In terms of investment liberalisation, the following points can be made in response to these criticisms. First, APEC has in place an institutional mechanism to pursue the goals of investment liberalisation. Second, significant liberalisation of investment regimes has occurred since APEC adopted this as a major policy goal in 1993-94. Third, the economic development concerns of the less developed APEC member economies have tended to slow the process. Fourth, political constraints in all member economies are a major barrier to further liberalisation. Both the economic development concerns and political constraints will need to be addressed if the Bogor goal of a free and open investment regime in the region by 2020 is to be achieved. Fifth, the liberalisation process is uneven because it is presently directed solely towards removing investment barriers with little attention to a corresponding reduction in investment incentives. This is a major shortcoming of APEC but not one that the business community or the business press raise often. Finally, in anticipation of a free and open investment regime emerging in the region, APEC economies are beginning to consider new policy measures that will be needed to complement a more open environment. It is useful here to consider each of these points in further detail. Most of the detailed initiatives for investment liberalisation in APEC emanate from the IEG. This group is a subcommittee of APEC’s Trade and Investment Committee which itself reports to the Senior Officials meetings. The recommendations of Senior Officials are passed to meetings of ministers and then on to Leaders. While the IEG undertakes many initiatives itself, it also receives suggestions for future initiatives from higher parts of the APEC hierarchy. Some of the major IEG’s achievements include the APEC investment guide, the NBIP developed in 172

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consultation with other parts of the APEC process, a menu of options that member economies can adopt to move the liberalisation process forward and regular investment seminars. However, perhaps the most significant achievement of the IEG is the learning through information exchanges at the regular IEG meetings. The IEG consists of officials of each member country’s investment agency and meets three times annually. While meetings tend to focus on liberalisation initiatives, information is shared through each member economy reporting on a regular basis on different aspects of its investment regime. There is some turnover in membership, yet the IEG process has the potential to devise and implement practical liberalisation initiatives in each member economy. The major criticism of APEC’s institutional mechanisms for liberalising both trade and investment revolve around the voluntary nature of the process. The alternative is a rule-based process binding member economies to implement specific measures. The main disadvantage of a rule-based approach is that binding agreement may be possible only on minor issues and appropriate wording for agreements can easily bog down discussions. A consensus-based approach on the other hand promotes discussion of much wider ranging initiatives. While members may not implement these initiatives immediately, regular meetings and reports and the peer pressure associated with these provides impetus for member countries to be seen to be doing something substantial to liberalise their investment regimes. The steps taken by APEC member economies towards investment liberalisation show that considerable progress has been made since 199394, when this issue was entrenched firmly on the APEC agenda. Since 1996, 17 of APEC’s 21 member economies have taken steps to liberalise their investment regimes. In the developed economies, both Australia and New Zealand have undertaken major investment policy reviews, resulting in higher thresholds for review of foreign investment proposals and in Australia’s case opening some sectors, including domestic airlines, to greater foreign participation. In Canada and the US, initiatives have been undertaken to facilitate foreign entry into the finance sectors. In Japan, the media and telecommunications industries have been removed from the restricted list but limitations on foreign equity still apply. Despite these initiatives, the developed economies still retain some screening of foreign investment and there are limitations on foreign investment in some countries’ agricultural sectors and in all countries’ sensitive service industries. These service industries include media, telecommunications, transport, finance and energy.

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In the group of NIEs, both Singapore and Hong Kong have maintained their relatively open approach to foreign investment. Since 1993, Korea has transformed its investment regime to the extent that now very few sectors are closed completely to foreign participation and few have restrictions on foreign equity. The screening process has been almost eliminated and a simple notification system is now in place. In Mexico, a new Foreign Investment Law was enacted in 1993 to coincide with Mexico’s accession to NAFTA. The new law contains an automatic approval mechanism for most classes of foreign investment. However, as with developed economies, restrictions still remain in the sensitive service sectors although Mexico has planned to further liberalise its transport industries. Taiwan has relaxed restrictions in real estate and telecommunications and is moving ahead with privatisation to allow foreign participation in many previously state-owned enterprises. The difference between Taiwan and other NIEs is that Taiwan still has a de facto screening mechanism for almost all foreign investment. The other countries in the NIE group have largely eliminated screening. In Singapore, however, many investors want to make use of incentives and therefore are subject to some form of monitoring by the Economic Development Board. In contrast to the NIE and developed economy groups, the developing and transition economies still retain extensive screening mechanisms and limitations on foreign investment in most sectors other than manufacturing. Even so, some liberalisation has been carried out since 1993-94. Peru has undertaken liberalisation measures in its mining, telecommunications and agricultural industries. Malaysia has removed equity limits on manufacturing investments although whether this policy will be continued beyond 2000 remains to be seen. Thailand has enacted a new Foreign Business Act. While this new act may not have gone as far as some foreign investors had hoped, the list of restricted industries is considerably shorter than under the old Alien Business law. The Philippines removed a whole category of restrictions on investment with the abolition of List C of its Foreign Investment Law in 1996. Papua New Guinea is currently reviewing its policy, aiming to move towards a more open regime. Indonesia has remained relatively restricted: all foreign investment needs approval and a relatively lengthy negative list details sectors that are either off limits to foreign investors or require some degree of Indonesian participation. In the transition economy group, China now has a list of encouraged, restricted and prohibited areas for foreign investment. This list was first

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promulgated in 1995 and was revised in 1997 with the aim of removing some of the restricted industries. However, the list of restricted areas remains lengthy and includes some industries where China feels there is already enough foreign investment. Vietnam does not publish a list of restricted industries in the investment guide. It does, however, have a list of encouraged areas, signalling that foreign investment is welcome only in the areas that are encouraged. Russia has not yet provided an entry in the APEC investment guide. Nevertheless, the Khabarovsky Krai region, which is most closely associated with APEC geographically, provides considerable detail of the procedures required for investors in a number of resource based industries. These are available on the investment agency’s website. This brief review of progress across the region suggests that liberalisation of investment regimes is proceeding in the APEC region. However, the pace at which liberalisation can continue depends on eliminating both economic development concerns and political constraints. With economic development concerns, the question is whether a completely open approach will produce the best developmental outcomes. There is a growing consensus that the most significant contribution that foreign investment can make to economic development is as a learning mechanism for local firms through passing on product, process and design technology as well as management and marketing skills. The competition that foreign investment brings also has the potential to encourage local firms to be more productive. A key issue is whether a completely open foreign investment regime is best suited to maximising these developmental outcomes. Economists disagree on this issue. Some argue that an open investment environment will result in net benefits for the host nation. This school of thought tends to assume first that the learning process occurs almost automatically and second that the risk of government failure is higher than the risk of market failure since government screening of foreign investment is likely to lead to rent seeking and misallocation of resources. Other analysts hold that some government intervention is warranted - through screening, foreign equity constraints and sectoral restrictions. In this view the diffusion of knowledge from foreign firms to local industry is not automatic and some policy measures are needed to ensure that this occurs. In other words, the risk of market failure is greater than the risk of government failure.

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The evidence is insufficient to confirm either position. There are major limitations on the data needed to determine the impact of foreign investment on developing local industry. Data is required across industries and for a long period of time. Either there is no data or only data for an insufficient timeframe to enable the detailed analysis necessary to determine developmental impacts. Thus one is left to rely on case studies of foreign investment in particular industries in particular economies. Although these studies are numerous, their findings are inconclusive as we find in detailed analysis of case studies for Malaysia, Thailand, Indonesia and China. Policymakers in developing countries are therefore unsure about the impact of rapid market liberalisation. The lessons from the NIEs are not really helpful since each adopted differing approaches to foreign investment at earlier stages of their economic development and the international economic circumstances also varied. In this situation policymakers in developing countries tend to be conservative and opt for gradual rather than rapid liberalisation. The difficulties in devising policy and appropriate measures are compounded if one takes political constraints into account. There are three major sources of political constraints on the liberalisation process. One is businesses whose interests will be adversely affected by a more open investment regime. In the US some businesses lobby for policy measures that will disadvantage foreign investment in their industry rather than restrict it completely. These measures have included restrictions on government procurement and rules of origin, and withholding subsides to foreign firms. In other countries, business has formed alliances with politicians to stall liberalisation in a number of sectors. We have considered examples of the finance sector in Malaysia, the retail sector in the Philippines and the composition of the restricted list in Thailand’s new Foreign Business Act. In all three cases liberalisation initiatives were either watered down or stalled. A second source of political constraint is politicians’ perception of general public attitudes to foreign investment. Anti-foreign sentiment raises its head in most countries from time to time. In the recent past, examples of public concern about foreign investment can be found in Korea, Indonesia, Thailand, Australia and New Zealand. Politicians take anti-foreign sentiment into account when deciding whether a particular liberalisation measure will adversely affect the public’s perception of their government and hence their own political future. In view of the liberalisation that has been achieved in recent years, it is difficult to argue

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that public sentiment has actually slowed down the liberalisation process. Nevertheless, the gathering forces opposed to globalisation may yet pose a threat to APEC’s agenda in this area if policies are not put in place to deal with the concerns of those involved in this opposition movement. A third source of opposition to liberalisation comes from within the bureaucracy itself. Bureaucrats are divided about the benefits of liberalisation depending upon how they see it serving their own interests and the wider interests of the sections of industry that they serve. As examples from China and Vietnam have shown, lower level bureaucrats can sidetrack liberalisation initiatives. The potential for this is greater in countries where all foreign investment is subject to approval, and business activity in general is subject to extensive licensing requirements. The situation is exacerbated if there are no avenues to challenge decisions. While there is little evidence readily available to substantiate the point, it seems reasonable to argue that business-bureaucrat alliances against foreign investment in some industries in some countries may at present constitute the major political constraint to liberalisation through removing investment barriers. National security concerns may constitute a further brake on liberalisation. However, we have seen, national security concerns do not provide sufficient justification for the many restrictions that remain in place. While the APEC process has made some progress in removing barriers to entry, there have been few, if any, initiatives on other side of the liberalisation equation: removing investment incentives. The APEC process is not alone here, with few initiatives globally to limit government incentives to attract greenfield investment. While organisations such as the OECD and UNCTAD have pointed out the disadvantages of investment incentive schemes, governments remain unconvinced. Economies in the APEC region compete vigorously for foreign investment in priority manufacturing industries and high technology industries, aiming to develop underdeveloped areas and provide jobs and spinoffs. We have seen that in Southeast Asia, governments offer an extensive array of tax incentives to entice foreign investors to establish themselves in industries that the State sees as priority areas for development. In the NEEs of Singapore, Taiwan and Korea, governments actively solicit foreign investment in industries designated as high technology industries. In the developed countries, there is competition at the sub-national level for major investment projects often by way of direct subsidies. Many examples from the US indicate that amounts of these subsidies are huge.

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All countries continue to try to attract foreign investment into underdeveloped areas. Thailand has perhaps the most elaborate scheme that divides the country into zones with progressively more generous incentives the further one moves from Bangkok. Malaysia and the Philippines also offer more generous incentives for investment in designated underdeveloped regions. Chile and Peru generally avoid the use of incentives but offer tax concessions for firms locating in remote regions. Some of the economically developed countries with smaller populations are bidding to become centres for RHQ; Australia, Malaysia and Singapore actively compete with tax concessions for this type of investment. Economists specialising in the field have reached a general consensus that tax concessions in particular are not effective to attract investment. Tax concessions make the difference in choice of location only in rare cases. Further, tax incentives involve a substantial loss of revenue to the State. This revenue could be used more productively to upgrade overall skill levels to enhance the possibility of gaining the advantages that foreign investment can provide, or to supply infrastructure and social safety nets for those hurt by the economic restructuring that often follows the opening of an industry to foreign participation. Tax incentives are not as effective at attracting foreign investment as direct subsidies, which disadvantages economically developing countries vis-à-vis the richer, more economically developed countries. As governments remove formal entry barriers to foreign investment, investment incentives may have a greater effect than they do at present on investment decisions of multinational firms. If so there is then the potential for even greater competition and hence loss of revenue as well as distortions in patterns of investment. This reasoning justifies inclusion of investment incentives on the APEC agenda, although competitive pressures and the usefulness of incentives as political tools makes this a difficult move. New policy initiatives will be needed as investment liberalisation proceeds in APEC. Two of these policy areas are corporate governance reforms and competition policies. I have argued that corporate governance standards will come to play a much more important part in the investment decisions of multinational companies. By far the greatest share of foreign investment is now through M&A, joint ventures and strategic alliances, all of which place the corporate governance practices of firms under detailed scrutiny. Thus, countries showing a commitment to improving and enforcing higher standards of governance in the firms within their jurisdiction may be better placed to continue to attract foreign investment

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flows. In addition, greenfield investment projects are increasingly in high technology industries with venture capital playing a more significant role. Venture capital companies will also be keen to ensure that high standards of corporate governance are operating before investing in such projects. As barriers to investment come down, competition policies will need to be in place to ensure that foreign firms are not put at a disadvantage to local firms. Foreign firms could be disadvantaged if host countries substitute formal entry barriers with operational restrictions, business practices and licensing procedures that favour local firms. As host countries generally see their position, competition policies are needed to guard against foreign firms either abusing positions of dominance in the marketplace, or putting in place restrictive agreements that favour their own suppliers rather than local suppliers. While APEC has started to give greater prominence to corporate governance and competition policy issues, some obstacles still need to be overcome. With corporate governance, the differing traditions of corporate organisation in the region make uniform practices difficult in the short­ term and require broadly based principles. With competition policy, differing views about the role that the state should play in the economy results in different views about the way in which competition policy should be implemented and enforced. If all countries in the region are in transition towards market led economies, then both corporate governance practices and competition laws may move towards convergence in the longer term. In the preceding pages I have suggested various measures that might facilitate the liberalisation process. It is worthwhile summarising these suggestions here in conclusion to this book. The first suggestion relates to the APEC Investment Guidebook. While this is a very useful document, its coverage is uneven. Some countries provide detailed information about restrictions in various sectors while others provide only the most general outline. In the interests of transparency, it may be useful to standardise the entries by setting out each sector and the restrictions that apply for foreign investors in that sector. It is possible to group industries together under fairly broad sector headings as I have done in Chapter 2. Chile’s action plan has adopted such an approach and it may provide a useful model to follow for further editions of the Investment Guidebook. It would also be useful for action plans to follow the same headings so that it is immediately apparent what further action is proposed in terms of liberalising each sector. The range and conditions of incentives also needs to be made more explicit.

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Second, we have noted the danger that as governments remove formal entry barriers, secondary barriers such as operational restrictions may be put in place as substitutes. This book has not dealt in detail with operational restrictions as these are often industry and country specific. Hence research in a number of industry sectors would help to identify the extent of these operational barriers. Priorities for this type of research could productively include the sensitive service sectors where most barriers are currently in place. Third, there is minimal research on the competitive effect of foreign investment in developed countries. Liu, et al. (2000) have noted that little work has been done, for example, to identify foreign investment related productivity improvements. More research exploring such pertinent issues is likely to assist policymakers in their decisions concerning liberalisation. A closely related issue that similarly begs further research is the impact of foreign investment in developed economies, with the work of Graham and Krugman on the US providing a useful model. Similar work for other developed economies in the region is difficult to find. The fourth suggestion emerges from the current state of the evidence concerning the economic impact of foreign investment on the economic development process. A database of sector specific case studies of countries in the APEC region would offer informative precedents for policymakers to consider in their liberalisation deliberations. This book has identified some of the case studies but it is likely some studies were not located. In terms of further work, studies such as that by Sjoholm (1999) on Indonesia could usefully be repeated for other countries in the region. The fifth suggestion also emerges from some pioneering work exploring the political constraints on investment liberalisation in the US. Crystal (1998) has provided a useful framework for analysing the political determinants of investment restrictions that could be adapted for other countries in the region. These studies need to be industry specific, but as such they will shed some light on the policy measures needed to overcome resistance to liberalisation in those industries. Finally, although the effectiveness of incentives has been well researched, much less work is available on the cost of incentives and on their potential distortionary effects. Research in both areas will be difficult. Governments are not always willing to reveal the cost of their incentive programs even if they are aware of them. It may be too early to assess the distortionary effects of investment incentives, except in those economies

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where barriers have been reduced in recent times. Korea stands out as a possible candidate here. The research I have proposed above does not guarantee solutions to the problems that it identifies. However thorough research will surely contribute to our understanding of the liberalisation process and facilitate more informed discussion of the issues that it raises. In the end result, a free and open investment regime in APEC will depend not only upon the availability of accurate information to inform policy decisions and foster supportive sentiment but also, crucially, upon maintaining the political commitment of member economies to the Bogor goals.

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Index Committee on Trade and Investment 3, 9, 10, 12, 15-18, 37, 168, 172 competition agencies 166-7 competition policy 2, 5, 83, 141, 145-6, 160-3, 165-71, 179 competitive spur 81, 89, 108 162, 170 comprehensiveness 30, 168 CONITE 67 corporate governance practices 5,145, 147-52, 154-6, 159-60, 169, 178-9

ABAC 11, 19, 23, 28-9, 32-4, 57, 76, 78 absorptive capacity 90, 92, 94, 98, 104 abuse of dominance 160, 166-8 accountability 151, 168-9 accounting bodies 151, 158 Action Plan Monitoring Committee 33 action plans 3, 9,11,13, 23, 29-34, 37, 42-7, 50, 58-9, 70, 73, 76, 179 AFTA21 Alien Business Law 112-13, 174 Anglo American model 146-7, 157, 159, 167 anti-competitive behaviour 160, 162 APEC business survey 36 APEC Finance Ministers 148, 152-3, 155-7, 170 APEC secretariat 11,13, 15, 20 approval process 35, 40, 47, 49, 52, 56, 69, 71-2, 75, 77, 145 ASEAN 21, 39, 64, 90, 102, 121, 125, 135, 137, 139 Asia Pacific Regional Operations Centre 106, 129 Asian crisis 6, 113-14, 117, 147-9,159, 168

Decree Law 600 66 démocratisation 118, 164 demonstration effect 89, 131 deregulation 12, 17, 21, 31, 51, 164, 168 disclosure 148, 150, 157 double taxation 28, 123, 135 dualism 104 economic development 1,4, 31, 34, 39, 56-7, 80, 89, 103-4,107, 172,1756,180 Economic Development Board 128-9, 174 economic development philosophy 141 Economic Ministers 10-12, 14—18, 2930, 32-4, 37 eminent persons 1, 9-10 equity limits 38, 58, 76, 174 EU 139 Exon-Florio amendment 42-4, 83-4, 86 export enclaves 98 export oriented manufacturing industries 122,142 export processing zones 65, 105,107, 122-4 expropriation 19, 25-6, 34

BKPM 59, 61 board committees 153 board of directors 147, 157 Bogor 1,3, 13, 18, 29, 33, 119, 161, 169, 172, 181 build-operate-transfer law 57, 65 bumiputeras 91, 98-9 business interests 111, 114 business-government relations 112, 169 CER21 CFIUS 42-3, 86 chaebol 107 COCHILCO 66 collective action plans 9, 30 collusive agreements 166

fairness 160 family firm 146-8 financial institutions 41, 43, 46, 73, 151, 154, 159 FIRB 46-7

197

198 Liberalising Foreign Direct Investment Policies in the APEC Region fire sale 82 foreign access zones 133 Foreign Business Act 59, 63-4, 75, 174, 176 Foreign Investment Committee 61-2, 66 foreign investment law 26, 52-3, 67, 76, 113,174 foreign investment ombudsman 53 foreign investment zones 133 Foreign Reserve Board 41 formal entry barriers 2-3, 5, 8, 19-20, 29, 34-5, 37, 3 9 ^ 0 , 49-53, 77-8, 161-2, 171, 178-80 free and open investment 19, 21, 23-4, 29,31,37, 52, 119, 172, 181 free industrial zones 124 free trade zones 99, 124-5 GATS 22-3 GATT 16, 24-5 greenfield investment 45, 48, 50, 56, 59, 132-3, 143, 145, 149, 170, 177, 179 high tech parks 128 high technology industries 62, 105-6, 128, 130, 149, 151 high technology investment 108, 127, 130, 142, 150 Hsinchu Science Park 105, 128 Hull formula 25-6 ICSID 27 IEG 3, 9, 12-13, 15, 18, 33^1, 36-7, 76, 172-3 IMF 49, 52, 76, 107, 117, 121, 134, 153 import duty concessions 120-1, 123, 134 import substitution 92, 109, 111 individual action plans 9, 23, 30, 32-4, 37, 58, 66 industry policy 101, 109, 113, 137, 141, 143, 163-5, 167, 169, 171 infant industries 100 institutional investors 151-2, 155, 158, 169 investment agencies 36, 38, 41, 56, 59, 116-17, 121, 141-2, 144-5, 165-7, 171, 173, 175 Investment Commission 54-5 Investment Guidebook 20, 22, 28, 31, 34, 37-8, 40-1, 51-2, 58, 62-3, 66, 68, 121, 127, 179

investment incentives 2, 4, 19, 23, 36, 38, 105, 108, 120, 127, 129, 134-5, 137, 139,140, 142-4, 150, 166, 172, 177-8, 180 Investment Priorities Plan 122 Investment Promotion Authority 68, 75, 166 Japanese model 133, 146-7 job mobility 96 joint ventures 35, 71, 99-102, 117, 145, 149-50,170, 178 KISC 52-3 Leaders Meeting 10-11,15-18, 30-1, 37 licensing 35, 49-51, 66-7, 108, 166, 177, 179 listing authorities 151, 154, 158, 169 local content requirements 50, 58-9, 101 local officials 115-16 M&A 42-3, 46, 48, 50, 56, 59, 61, 82, 132, 145, 149, 150, 170, 178 MAI 140 manufacturing licence menu of options 9, 10, 13, 32-6, 38, 173 MERCOSUR 21 MIDA 61-2 Ministry of Planning 74 MNC 89, 93-4, 103-4, 128, 132 MOFTEC 70-1 multi-media supercorridor 130 NAFTA 6, 8, 19, 21-2, 44, 46, 49-51, 53, 109, 139, 174 national security 19, 42, 48, 50, 79, 834, 118, 174 national treatment 19, 22-3, 29, 35, 378, 40-2, 48-9, 52, 68, 70, 77, 166 nationalism 26, 112 NBIP 3, 9, 11, 13, 19, 22-7, 29-31, 334, 37, 40, 44-5, 52, 172 NCFI50, 54 negative list 55-6, 59-60, 63-5, 105, 174 NIEs 3, 4, 39, 49-51, 55, 75-6, 79, 80, 83-5, 87, 92, 101, 103, 118-19, 130, 142, 174, 176-7

Index 199 non-discrimination 19, 21, 29-30, 34, 37,168 notification system 48 OECD principles 155-7,159,169-70 OIC47 open regionalism 1,21 operational restrictions 8, 20, 36, 53, 161, 179-80 Osaka Action Agenda 30-1,41 Overseas Chinese 147 ownership requirements 35 PBF17 PECC 13, 18, 32, 168 performance requirements 19, 24, 28-30, 36-8, 40, 44, 46-7, 50, 58, 69, 88, 99,100, 102 pioneer industry 121-2, 129 political constraints 3, 4, 8, 33, 56, 76, 80, 84, 87, 109, 119, 172, 175-7, 180 priority manufacturing industry 120-1, 126, 177 privatisation 50-1, 55, 57, 62, 64-6, 76, 109, 115, 164, 174 productive enterprise 122-3 productivity 89, 94, 104, 180 promoted industry 122, 130 R&D 82, 92, 94, 106, 108, 128-31 reciprocity 41-4, 48, 77, 85-6 regulators 73, 151, 153, 169 rent seeking 69, 102, 160, 175 restrictive business practices 168 RHQs 131-2,178 screening processes 35, 37, 99,100,145, 162, 174 sectoral restrictions 2, 3, 35, 37, 85,100, 102,142,145,163,175 Securities Exchange Commission 64, 65 Senior Officials 10-16,18, 29, 31,37, 172

Seoul declaration 14-15 shareholder rights 150, 153 special tax deductions 121-2 spillovers 94, 104, 110 stakeholders 146-8, 153, 155-7, 159, 169 state intervention 163-4,167 Statute for Investment by Foreign Nationals 54-5 strategic alliances 106, 145, 149-50, 170, 178 strategic trade 82 sub-national agencies 132 tax credits 123, 128, 132 tax holidays 59, 120-3, 125-30, 133-7, 142-3 tax rate reductions 121, 134-5, 137 tax sparing 123, 135, 143 technological capability 4, 94, 106-7, 110, 127, 130 technology transfer 14-16, 18, 79, 8896, 99, 101, 113 training 13, 31, 34, 36, 38, 92, 94, 96, 98, 102, 108, 110, 126, 128, 138-9 transnationality index 6-8 transparency 9, 19-21, 23, 29, 33-4, 37, 40, 49, 52, 77, 179 Treaty of Amity and Cooperation 114 TRIMs 24, 30, 122, 139 UNCTAD 5-7, 22-3, 29, 34, 87, 97, 100-1, 107, 110-11, 134, 139,14950, 177-8 underdeveloped areas 126-7 US subsidy programs 44 venture capital 145, 149-51, 170, 179 World Bank 88, 102, 134, 153, 155,158, 160 World Economic Forum 117 WTO 29-31, 34, 45-6, 50-1, 69, 76, 106,117, 122, 139