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Harnessing Foreign Direct Investment: Policies for Developed and Developing Countries - Q&A with Theodore Moran

February 26, 2007

Theodore H. MoranThis new book by CGD non-resident fellow Theodore H. Moran shows that Foreign Direct Investment (FDI) can provide a powerful boost to development, but can also distort host economies, including through grand corruption, with serious adverse consequences. Ahead of the planned launch of the book on March 8, Moran explains the key findings:

Q: What's the central finding in your new book?

A: The Washington Consensus may have argued that foreign direct investment (FDI) was "good," and the more the better. But the evidence in this volume shows that FDI comes in both "good" and "bad" forms. The book divides FDI into three sectors -- extractive industries, infrastructure and manufacturing and assembly. In each, FDI comes in a "good" or beneficial form that contributes to host country development, and a "bad" or harmful form that hinders or subtracts from host country development.

Q: What policies can developing countries adopt to ensure that FDI is as productive as possible?

A: In extractive industries like petroleum and mining, host authorities need to ensure that foreign investors report publicly all taxes and other payments made within the country, to ensure that revenues are not siphoned off for private gain.

In infrastructure, host governments should insist that foreign investors assume the commercial risks of, for example, a reduction in demand for power or other services when economic growth slows. This is preferable to sticking the public with take-or-pay contracts that must be met no matter what happens in the world economy.

In manufacturing and assembly, host countries benefit most from multinational plants that form an integral part of the parent's global competitive strategy. Here well-trained workers and effective vocational skill-building programs act as a magnet in attracting foreign investors; poor labor standards do not. FDI can be used for broad development as local firms become suppliers and contract manufacturers for the multinational plants.

Q: Are there things that rich countries can do--or should refrain from doing--to encourage their firms to make constructive investments in developing countries?

A: Both developed and developing countries have a common interest in supporting the Extractive Industry Transparency Initiative (EITI) that requires all extractive investors -- including those from China and Russia as well as OECD countries -- to "publish what they pay" and encourages host authorities to publish how they spend all revenues they receive. Multilateral lending institutions like the World Bank and NGOs like Global Witness can help by building up local capacity to monitor the expenditures of foreign companies and host governments.

As for FDI in manufacturing and assembly, political risk insurers in rich countries should screen out subscale projects oriented toward protected local markets that retard the development of the host economies where they are located. The growth of efficient international supply chains across borders, in contrast, produce win-win outcomes for workers as well as consumers in both rich and poor countries.

Q: You report that there are loopholes in the U.S. Foreign Corrupt Practices Act and the OECD Convention to Combat Bribery that make it possible for multinationals to offer bribes without risking prosecution. Can you describe how that works?

A: Yes: anti-corruption laws in the developed countries -- as now written -- criminalize the payment of bribes to host country officials. But the research in this book shows how U.S., European and Japanese multinationals have formed fake "partnerships" with family members and associates of government leaders in which the multinationals have lent the capital to the family members and cronies to set up the partnerships, and paid a dividend high enough to cover interest on the loan and extra money to go into the pocket of the "partners."

Q: How could this loophole be closed, and would doing so make a difference?

A: CGD has set up a Working Group to find ways to close these loopholes. While our recommendations are not yet final, we believe that rich country anti-corruption laws can be reformed and -- importantly -- that multinational investors whose concessions have been obtained through corruption should not have recourse to enforce their contracts in international arbitration. This would mean that all investors -- including investors from countries where home country controls on corruption are not strong, such as Russia and China -- would think twice about using illicit payments to secure a concession, since they could lose their holdings.