Jason Michael FaussNovember 20, 2016Columbia, SIPADr. Akbar Noman & Dr. José Antonio Ocampo2,400 words

Betting on Indigenous Innovation vs Inward FDI: A Challenge to the Neo-liberal AgendaSouth Korean and Brazilian inward FDI policies and their effects on economic development

Foreign direct investment—the merging or acquiring of a domestic corporation by a foreign

one—has long been a macroeconomic tool for economic growth and development. In the last

decade, however, economists have engaged in lively debate over the question: what role does

inward FDI play in economic development and how can it be most effectively utilized? Though

there is no single blueprint for successful development that specifies the quantity and sectorial

location of inward FDI, studying the different policies of developing countries gives one

perspective and insight in the creation of new frameworks. In this essay, I will first give a

historical background of inward FDI and its relationship to development. Second, I will

challenge the neo-liberal macroeconomic agenda by comparing and contrasting South Korea’s

approaches to inward FDI from 1965 to the late 70s with Brazil’s in the 1990s. Lastly, I will

apply the South Korean-Brazilian comparative case study to our contemporary, theoretical

understandings of the relationship between inward FDI and economic development.

Background

Many developing countries, especially after the Washington Consensus, warmly welcomed

inward FDI because of their enthusiasm for the free market, deregulation, and liberalization of

investment. This neo-liberal agenda perceived inward FDI as capable of catalyzing “technology

spillovers, human capital formation, international trade integration” as well as a means to “help

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create a more competitive business environment and enhances enterprise development.”1 Other

developing countries, however, were wary of inward FDI because they feared that merging their

domestic enterprises with foreign enterprises would lead them to be dependent or outcompeted in

sectors entirely acquired by foreign corporations. Alternatively, these countries pursued

indigenous innovation agendas that sought to make corporations and sectors “self-reliant,

independent, and indigenous.” 2 While accepting inward FDI is a form of cooperation seeking to

develop bilaterally, indigenous innovation tends to be more isolated and deglobalized, often

strictly regulating inward FDI flows. No approach is employed absolutely so it is not a question

of whether inward FDI is good or bad; it is a question of the degree of restriction. What sectors

should the government open up to inward FDI and how open should these sectors be? The neo-

liberal agenda pursued openness towards inward FDI because they believed that foreign injection

of capital would modernize domestic companies who “emulate the more advanced techniques of

their foreign competitors.”3 Borrowed modernization, however, does not result in stable

development. In order to achieve stable development, inward FDI needs to “spark indigenous

learning and capability formation which does not seem to be automatically the case.”4 We begin

to see development more cogently when we shine the light on the South Korean stance towards

inward FDI from 1965 to the late 70s and Brazil’s in the 1990s.

South Korea

1 OECD Organisation for Economic Cooperation and Development. "Foreign Direct Investment for Development: Maximizing Benefits and Minimizing Costs." (2002): n. pag. Web. <https://www.oecd.org/investment/investmentfordevelopment/1959815.pdf>.2 Bichler, Josef. "The Chinese Indigenous Innovation System and Its Impact on Foreign Enterprises." Munich Business School Working Paper (2012): n. pag. Web. <http://www.munich-business-school.de/fileadmin/mbs_daten/dateien/working_papers/mbs-wp-2012-01.pdf>.3 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. 39. Print.4 Tang, Mingfeng, and Caroline Hussler. "Betting on Indigenous Innovation or Relying on FDI: The Chinese Strategy for Catching-up." Technology in Society 33.1-2 (2011): Page 25. Web. <http://fulltext.study/article/375221/Betting-on-indigenous-innovation-or-relying-on-FDI-The-Chinese-strategy-for-catching-up>.

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South Korea from 1965 to the late 70s is an example of a country that successfully

developed counter to the neo-liberal model by prioritizing indigenous innovation over inward

FDI. The 1966 Foreign Capital Inducement Law was a major piece of legislation that regulated

inward FDI, loans, and technology while simultaneously providing “privileges, tax incentives,

and repatriation of capital” 5 to domestic enterprises. South Korea’s policies were targeted,

“welcoming [inward FDI] with open arms in certain sectors while shutting it out completely in

others.”6 Sectors including “banking, hotels, insurance services and real estate” were severely

closed to inward FDI “so as to protect the monopoly interests of local firms.”7 The government’s

more “export oriented”8 approach in manufacturing is evident in its establishment of a free trade

zone in Masan in 1970. The zone allowed domestic corporations to operate without the

intervention of customs authorities and “provided an industrial estate where land, utilities,

transport facilities, and even buildings were supplied by the government at highly subsidised

rates.”9 Jean Aden, Ahn Kyu-Hong, and Michael Rock studied the effect of South Korea’s

manufacturing sector restrictions on FDI in 1999 and “found that domestic firms performed

better than foreign-owned firms, a result [they] attributed to the sensitivity of South Korean

chaebol to public criticism.”10 Had South Korea opened up its manufacturing sector to inward

5 Nicolas, F., S. Thomsen and M. Bang (2013), “Lessons from Investment Policy Reform in South Korea”, OECD Working Papers on International Investment, 2013/02, OECD Publishing. Page 15. <http://dx.doi.org/10.1787/5k4376zqcpf1-en>.6 Chang, Ha-Joon. "Mozambique’s Economic Miracle How to Escape Poverty." The Economist (n.d.): Xxi. 2007. Web. <https://analepsis.files.wordpress.com/2011/08/ha-joon-chang-bad-samaritans.pdf>.7 Nicolas, F., S. Thomsen and M. Bang (2013), “Lessons from Investment Policy Reform in South Korea”, OECD Working Papers on International Investment, 2013/02, OECD Publishing. Page 15. <http://dx.doi.org/10.1787/5k4376zqcpf1-en>.8 Kumar, Nagesh. "Liberalisation, Foreign Direct Investment Flows and Development: Indian Experience in The1990s." (n.d.): 1468. Economic and Political Weekly, Vol. 40, No. 14 (Apr. 2-8, 2005). Web. <http://www.jstor.org/stable/4416435>.9 Nicolas, F., S. Thomsen and M. Bang (2013), “Lessons from Investment Policy Reform in South Korea”, OECD Working Papers on International Investment, 2013/02, OECD Publishing. Page 15.10 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Print. Page 222.

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FDI, overall growth and development would have been hampered by the underperformance of

foreign firms. Instead, the government not only targeted sectorial investment, but also hand-

picked entrepreneurs which created the Chaebol business conglomerate.

South Korea’s high-tech sector was also relatively restricted which is an approach that

can be very dangerous. Inward FDI allows for the acquisition of knowledge which is crucial to

development, especially in high-tech. South Korea’s restrictions of investments in specific high-

tech sectors was risky and “the bet in these cases was that domestic firms could in fact emerge,

and it paid off.”11 Domestic high-tech firms developed and modernized thanks to heavy

government subsidies and investments in domestic research and development programs (R&Ds).

Such programs were a result of LIT (learning, industrial and technology) policies whose merit

are highlighted by Noman and Stiglitz in their research on “Good Growth and Governance for

Africa”.12 Noman and Stiglitz write that “LIT policies are about dealing with issues of learning,

and of infant industries and economies; they focus on externalities and knowledge spill-overs;

they typically (especially in Asia) consisted of promoting exports and the private sector.”13 South

Korea’s LIT policies focused on more capital and technology-intensive industries such as

machinery and chemicals. To make champions in these industries, the government implemented

training programs such as the Institute of Machinery and Metals (KIMM) and the Korea

Research Institute of Chemical Technology (KRICT).14 In isolation, restrictions on foreign

ownership of the equity of domestic companies and import-substitution measures economically

disadvantage a state. In South Korea, the disadvantages of restricted FDI, however, were offset

11 IBID. Page 24.12 Noman, Akbar and Stiglitz, Joseph (2012), “Introduction and Overview” in Noman, Akbar et.al. (eds), Good Growth and Governance in Africa: Rethinking Development Strategies, New York: Oxford University Press.13 IBID. Page 25.14  Chung, Sungchul. "Innovation, Competitiveness and Growth: Korean Experiences." Science and Technology Policy Institute (STEPI) World Bank (1996): Page 5. Web. <http://siteresources.worldbank.org/EXTABCDE/Resources/7455676-1288210792683/Sungchul-Chung.pdf>.

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by the government’s “aggressive favoring of foreign loans and technology licensing over FDI.”15

South Korea’s robust indigenous innovation policies and relatively high restrictions on inward

FDI catalyzed development and consequently challenge the neo-liberal agenda.

Brazil

Brazil’s development model in the 1990s is another challenge to the neo-liberal agenda.

Theirs, however, is a challenge not because it had successful indigenous innovation policies, but

because it had arguably unsuccessful inward FDI policies. Beginning in the 1990s, Brazil began

removing a plethora of foreign capital restrictions and FDI regulations via the 1991 amendment

of its Informational Technology Law and 1993 revision of its constitution (which removed the

distinction between domestic and foreign companies). At the same time, Brazil began

eliminating sector-specific industrial and technology policies. Contrary to South Korea, Brazil’s

deregulatory approach valued “’horizontal’ policies” that affected “all sectors uniformly.”16 This

deregulation resulted in an influx of FDI which the Brazilian government welcomed because it

purported that it would modernize Brazilian industries through knowledge acquisition and

imitation of the foreign companies’ superior characteristics.

Sanjaya Lall studied the effects of Brazil’s horizontal policies and published his

findings17 at the 2004 UN Conference on Trade and Development.18 He concluded that from a

microeconomic perspective, “despite the fact that foreign affiliates show higher levels of

productivity, foreign trade integration, innovation, and wages than domestic companies, their

influence over the latter was very limited and, in some cases, even had negative spillover effects 15 World Bank (1993) “The East Asian Miracle” Washington D.C.: The World Bank. Page 22.16 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Page 49. Print.17 Lall, S. (2004). Reinventing industrial strategy: The role of government policy in building industrial competitiveness. G-24 Discussion Paper Series. UN Conference on Trade and Development. New York: United Nations.18 UNCTAD (2002). World Investment Report 2002.New York: United Nations Commission on Trade and Development.

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in productivity and access to foreign markets.”19 Mariano Laplane and Fernando Sarti echo these

conclusions in their 2002 study20 which found that “the large share of FDI attributable to mergers

and acquisitions shows that a substantial part of the investment inflows did not contribute to the

development of new productive capacity.”21 The negative effect on high-tech productivity was

perhaps most damaging. Unlike South Korea, Brazil did not produce many, if any, domestic

high-tech industries that could compete internationally. In many of Brazil’s domestic high-tech

sectors, inward FDI crowded out domestic industries instead of growing and modernizing them.

While South Korea adopted “active industrial and technology policies (e.g., technical and higher

education, support for basic research, financing and incentives to R&D activities),” Brazil did

not and lacked “selective investment policies, structured to channel investment to strategic

sectors.”22

The government’s laissez faire approach failed to create policies that stimulated rigorous

entrepreneurship and consequently, “technological requirements [ran] too far ahead of domestic

capabilities.”23 This is, however, not to argue that inward FDI failed to stimulate the Brazilian

economy entirely. 1990s inward FDI did have “indirect positive impacts [that] were seized by a

group of less productive companies that compete less directly with the foreign corporations,

probably in market niches.”24 However, these positive effects were inefficiently absorbed and

leave queries as to what was vs what could have been.

Theoretical Applications19 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Page 49. Print.20 Laplane, Mariano and Sarti, Fernando et al. (2001). El caso brasileño. In El boom de las inversiones extranjeras directas en el MERCOSUR. D. Chudnovsky (ed). Buenos Aires: Siglo XXI21 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Page 35. Print.22 IBID. Page 49.23 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Page 24. Print.24 IBID. Page 40-41.

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When comparing South Korea to Brazil, it is crucial that we acknowledge the linguistic

nuance of the word ‘challenge’. The two case studies are a challenge to the neo-liberal agenda,

not examples that definitively disprove it. The comparative case studies do, however, beg the

question: would Brazil have been more successful had it adopted South Korea’s policies? As

previously mentioned, no blueprint works universally and studying alternative blueprints is

difficult because they are counterfactuals; we cannot go back in time, restructure Brazil’s

policies, and study the outcome. Though counterfactuals are unobservable from a comparative-

methodological perspective, they do leave economists wondering if a more illiberal approach—

such as streamlining sector-specific regulations—may have stimulated growth and development

more than the horizontal approach. Copying and pasting South Korea’s model into Brazil would

be foolishly ignorant of cultural, social, and political elements that change over time.

Development economics is not limited to just one blueprint that instructs where and how much

inward FDI is best for a developing country. Instead, developing countries should focus on

dynamically transforming their institutions and policies by catering to the unique time and

locality. As Gerschenkron aptly puts it, “no past experience, however rich, and no historical

research, however thorough, can save the living generation the creative task of finding their own

answers and shaping their own future.”25

The Brazilian case study further emphasizes this point when we note that Brazil’s history

of regressive FDI policies with regard to knowledge acquisition actually began on the wrong foot

long before 1991. In the early 1980s, Brazil’s ‘informatics policies’ severely restricted foreign

investments in its information-technology sectors for the same reasons South Korea did in the

70s. However, these restrictions were disastrous and “led to very little domestic investment, and

25 Gerschenkron, Alexander (1962), Economic Backwardness in Historical Perspective: A Book of Essays, Cambridge, Mass: Harvard University Press, chapters on “Economic Backwardness in Historical Perspective”, pp. 531, and “The Approach to European Industrialization: A Postscript”, Page 6.

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the firms that were created were highly inefficient.”26 Brazil’s motivation for liberalizing the

high-tech market in the 1990s—in addition to pressure from Washington—was, to an extent, a

fear of repeating the past. Development economics teaches us, however, that just because a

model failed a country in the past does not mean that it is doomed to fail the host country

indefinitely. It is very possible that 1990s Brazil could have redeemed its 1980s model had it

subsidized its high-tech industries and strategically targeted the allocation of inward FDI.

Counterfactuals and comparative conjectures aside, the most important lesson to be learned is

that a greater focus ought to be on institutions and the transformation of its policies relative to

the given time and locality. Simply copying and pasting an economic model can be disastrous

and lead to market failure if there is a “lag in the development of political institutions behind

social and economic change.”27 FDI is important, but appropriate institutions and policies are

needed in order to reap the full benefits of inward FDI.

Though both the South Korean and Brazilian case studies present a challenge to the neo-

liberal agenda, further analysis of equity and democratization is needed if one is to make firm,

theoretical conclusions about development. Economic growth is necessary but not sufficient for

development. We would be foolish to merely observe rates of GDP growth and levels of

productivity because, as Anne Krueger aptly puts it, this assumes “that a successful government

will undertake policies that result in a satisfactory rate of growth of living standards relative to

the available resources.”28 This is often not the case. Though South Korea experienced greater

modernization and rapid GDP growth relative to Brazil, it did not necessarily equitably distribute

wealth or foster democratic institutions that allow for freedom of speech and expression. Such an

26 Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. Page 24. Print.27 Huntington, Samuel P. (1968), Political Order in Changing Societies, New Haven: Yale University Press. Page 4.28 Krueger, Anne (1990), "Government Failures in Development," Journal of Economic Perspectives, Summer, 1990. Page 12.

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analysis of pareto efficiency and whether or not equity and democratization preclude

development would be normative in nature and an excellent extension to this think-piece.

However, in a short essay like this, (analyses of equity and democratization aside) the South

Korean and Brazilian case studies reveal that inward FDI is important but the proper institutions

and policies are necessary to reap its full benefits.

Works Cited

1. Bichler, Josef. "The Chinese Indigenous Innovation System and Its Impact on Foreign Enterprises." Munich Business School Working Paper (2012): n. pag. Web. <http://www.munich-business-school.de/fileadmin/mbs_daten/dateien/working_papers/mbs-wp-2012-01.pdf>.

2. Chang, Ha-Joon. "Mozambique’s Economic Miracle How to Escape Poverty." The Economist (n.d.): Xxi. 2007. Web. <https://analepsis.files.wordpress.com/2011/08/ha-joon-chang-bad-samaritans.pdf>.

3. Chung, Sungchul. "Innovation, Competitiveness and Growth: Korean Experiences." Science and Technology Policy Institute (STEPI) World Bank (1996): 5. Web. <http://siteresources.worldbank.org/EXTABCDE/Resources/7455676-1288210792683/Sungchul-Chung.pdf>.

4. Driffield, Nigel, and James H. Love. "Linking FDI Motivation and Host Economy Productivity Effects: Conceptual and Empirical Analysis." Journal of International Business Studies, Vol. 38, No. 3 (May, 2007) Palgrave Macmillan Journals (n.d.): 460. Print.

5. Gallagher, Kevin, Daniel Chudnovsky, and Jose Antonio. Ocampo. Rethinking Foreign Investment for Sustainable Development: Lessons from Latin America. London: Anthem, 2009. 39. Print.

6. Gerschenkron, Alexander (1962), Economic Backwardness in Historical Perspective: A Book of Essays, Cambridge, Mass: Harvard University Press, chapters on

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“Economic Backwardness in Historical Perspective”, pp. 531, and “The Approach to European Industrialization: A Postscript”, pp 353-364.

7. Huntington, Samuel P. (1968), Political Order in Changing Societies, New Haven: Yale University Press, ch. 1. Print.

8. Krueger, Anne (1990), "Government Failures in Development," Journal of Economic Perspectives, Summer, 1990. Pages 9-23.

9. Kumar, Nagesh. "Liberalisation, Foreign Direct Investment Flows and Development: Indian Experience in The1990s." (n.d.): 1468. Economic and Political Weekly, Vol. 40, No. 14 (Apr. 2-8, 2005). Web. <http://www.jstor.org/stable/4416435>.

10. Lall, S. (2004). Reinventing industrial strategy: The role of government policy in building industrial competitiveness. G-24 Discussion Paper Series. UN Conference on Trade and Development. New York: United Nations.

11. Laplane, Mariano and Sarti, Fernando et al. (2001). El caso brasileño. In El boom de las inversiones extranjeras directas en el MERCOSUR. D. Chudnovsky (ed). Buenos Aires: Siglo XXI

12. Nicolas, F., S. Thomsen and M. Bang (2013), “Lessons from Investment Policy Reform in South Korea”, OECD Working Papers on International Investment, 2013/02, OECD Publishing. Page 15. <http://dx.doi.org/10.1787/5k4376zqcpf1-en>.

13. OECD Organization for Economic Cooperation and Development. "Foreign Direct Investment for Development: Maximizing Benefits and Minimizing Costs." (2002): n. pag. Web. <https://www.oecd.org/investment/investmentfordevelopment/1959815.pdf>.

14. Tang, Mingfeng, and Caroline Hussler. "Betting on Indigenous Innovation or Relying on FDI: The Chinese Strategy for Catching-up." Technology in Society 33.1-2 (2011): 25. Web. <http://fulltext.study/article/375221/Betting-on-indigenous-innovation-or-relying-on-FDI-The-Chinese-strategy-for-catching-up>.

15. UNCTAD (2002). World Investment Report 2002.New York: United Nations Commission on Trade and Development.

16. World Bank (1993) “The East Asian Miracle” Washington D.C.: The World Bank. <http://documents.worldbank.org/curated/en/975081468244550798/pdf/multi-page.pdf>.

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