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News Release

A "Grand Bargain" to Eliminate Distortions to Foreign Direct Investment

December 17, 1998

Contact:    Theodore H. Moran    (202) 687-5854

Washington, DC—A new study from the Institute for International Economics concludes that conventional trade wars are being replaced by investment wars to determine important contours in the shape of economic geography around the world. Developing and transition economies are undermining their own interests, however, by applying domestic-content requirements, joint-venture requirements, and technology-sharing mandates to incoming foreign direct investment. OECD countries are similarly hurting their interests by deploying locational subsidies, rules of origin, and antidumping regulations. Economic reformers in the South and North should therefore join forces to create a genuinely level playing field for international direct investment, according to Theodore H. Moran in Foreign Direct Investment and Development: The New Policy Agenda for Developing Countries and Economies in Transition. The interests of both capital-exporting countries and capital-importing countries could be served by a "Grand Bargain" that eliminates investment distorting measures in both developed and developing economies.

Foreign direct investment is now by far the largest source of all capital flows to the less developed world, climbing to $120 billion per year by early 1998, nearly half the total. When allowed to operate free of distortionary policies on the part of host countries, the evidence from the sectors where the spread of foreign manufacturing activity has been most extensive—automobiles and auto parts, petrochemicals, and electronics/computers—shows that full-scale foreign plants, integrated into the global sourcing network of the parents, provide benefits to the economies where they are located far in excess of the capital, management, and marketing commonly assumed. They provide newer technology, more rapid technological upgrading, and closer positioning along the frontier of best management practices and highest industry standards, than any other method for the host country to acquire such benefits.

Host countries that insist foreign firms meet high domestic-content requirements, take on local partners, or engage in technology-sharing agreements, by contrast, suffer lags in technology acquisition, absence of best management techniques, weak penetration of foreign markets, and flimsy development of a supplier base. Yet developing countries and economies in transition continue to find ways to protect and reward foreign investors who promise to meet domestic content, joint venture, or technology-sharing requirements.

Governments in the developing world and economies in transition, however, are not the only parties that are engaging in distortionary tactics to shift international direct investment in their own direction. In reaction to the globalization of manufacturing activity, developed countries have been intervening in the marketplace to capture and hold international corporate operations in ways that run contrary to international comparative advantage.

One prong of this counteroffensive has been the growing use of investment subsidies: international companies are now making their locational decisions in the midst of a fierce subsidy war in which locational incentives within the OECD of more than $50-100,000 per job are acting as tie-breakers at the margin. A second prong of this counteroffensive has been the use of protectionist and investment-diverting trade measures, most notably rules of origin and antidumping regulations, in a discriminatory and demonstrably distortionary manner.

Instead of engaging in ever-more-intense beggar-thy-neighbor tactics, economic reformers in the developing countries and economic reformers in the developed countries should join in a "Grand Bargain" to eliminate the most objectionable investment-distorting policies of all parties. Such arrangements should be worked out under the auspices of the World Trade Organization in the context of the next major round of multilateral trade negotiations.