Globalization's political economy and the role of the state

by Chakravarthi Raghavan

GENEVA: The gap between theories and the actuality of benefits
of free capital flows, inward and outward, and TNCs and their
international production are brought out in three studies of
Nordic countries, the transition economies of East and Central
Europe and Russia, and Latin America, in the book,
Transnational Corporations and the Global Economy, by
Macmillan Press of London containing edited papers of a UN
University/WIDER conference at Cambridge in 1995.

The book is edited by Richard Kozul-Wright and Robert

The three country-regional studies, presented in separate
chapters, are: of "Internationalization of industrial firms"
in the Nordic countries by Pontus Braunerhjelm, Per Heum and
Pekka Yl-Antilla; on the effects of transnational corporations
(TNCs) in East and Central Europe and Russia by Mihaly Simai,
and on Mexico by Michael Mortimore.

The Nordic study brings out that there has been a negative
substitutional effect of foreign direct investment (FDI) by
technologically advanced firms in domestic industrial
production, while the growth effects are more ambiguous. And
the outward investments of Nordic firms in the former
socialist economies (Baltic states and the Russian Federation)
have resulted in an acceleration of structural change in the
home countries, with decreasing employment in low-skill and
low-tech industries.

However, the study concludes, new capital controls on
outward FDI do not consitute a policy alternative. Instead,
policy efforts should attempt to promote the strength and
competitiveness of the domestic industrial base to attract
internationally competitive footloose firms, whether they are
of domestic or foreign origin.

The policy emphasis needs to move more and more rapidly
from product markets to factor markets. The main task of
industrial policies of small advanced economies is to ensure
that the elements determining competitiveness create a
favourable environment towards areas with positive
externalities - above all, education, technical and social
infrastructure and R & D. The policy goal should not be the
reallocation of existing resources but rather the quality and
quantity of resources for the future.

Great expectations

Mihaly Simai, in his chapter on TNCs and the former
socialist economies, notes there had been expectations in the
West and the East in relation to the direct and indirect role
of TNCs in the transition to the markets. The new governments
had expected a very fast increase in FDI in important branches
of the economy that could change rapidly the economic position
and performance of these countries in the world market by
introducing new technologies, new production and processes,
expertise and skills, and, at the same time, promoting
exports. Some of the governments had also looked to the TNCs
primarily as sources of new capital.

And while FDI to these countries grew rapidly between 1990
and 1994, much faster than the global average, and the FDI
stocks increased rapidly, in 1994 they represented less than
1% of world stock of FDI and, in per capita terms, about 11%
of the world average.

And while it is too early to draw a firm balance on costs
and benefits, the expectations of a new gold rush have not
materialized so far, though the impact of TNCs has been
greater than the volume of investment flows and stocks would

In macroeconomic terms, the structure of investments by
TNCs in the former socialist countries has reflected more the
motivation of foreign investors than the declared priorities
of host countries. A large part of the FDI has been
concentrated in highly profitable trade and services sectors,
which do not require large investment commitments. Less than
half has gone into manufacturing and about one quarter of the
total ventures are mostly in middle- or lower-level

In Russia, almost 50% went to fuel industries, 10% to
extractive branches, 10% to construction industries and close
to 11% to trade and transport.

With regard to privatization, domestic policies for rapid
privatization with foreign participation received strong
support and impetus from the World Bank, IMF and Western
governments. Fiscal motivations, including increase of
foreign exchange inflows, dominated the expectations of the
transition governments, especially the heavily indebted
countries, who looked towards privatization for reducing
budgetary deficits. And local entrepreneurs had no or very
little capital to purchase state enterprises.

Between 1990 and 1994, about 40% of the total inflow of FDI
was related to privatization. The role of foreign firms in
this area has been complex. Privatization involving TNCs has
been concentrated predominantly in large-scale and
strategically important industries like telecommunications,
oil, transport equipment and chemicals.

Some of the governments, and academia, entertained great
expectations concerning the technological transformation of
these economies as a result of the entry of TNCs. There had
been high hopes that their oversized research sector would be
one of the first to profit from the global sourcing activities
of TNCs in knowledge-based industries.

So far, this has been achieved only on a very limited
scale. Some of the Western firms have been especially
interested in getting the achievements of defence-related R&D
in Russia.

But TNCs, in general, proved to be reluctant to undertake
significant development activities outside their home country,
except in highly specific cases, when foreign scientific
capabilities offered something extraordinary.

And while there have been some green-field investments that
have contributed to the modernization and restructuring of
important branches of these economies, they have concentrated
on middle-level technologies.

New ventures with foreign capital have contributed to the
introduction of new products and services for consumer
markets, and, in certain branches, to exports, including
integration into the international supply system of the given

But in many cases, product innovation meant the
introduction of the brands of the TNCs which replaced the
existing and often much cheaper (though technologically
inferior) domestic brands.

In some countries, particularly in telecommunications, the
FDI contributed to the increase in and upgrading of services
and output.

But expectations that the inflow of FDI would result in
increasing demand for local subcontracting have not been met;
the potential even in the more successful instances, has not
been fully realized.

Empirical experiences suggest that in general, TNCs use
fewer domestic inputs than comparable domestically owned

TNCs and foreign trade

In terms of foreign trade and external market integration,
the contribution of foreign firms to export and import trade
has been quite important. As the affiliates became integrated
into the global production and supply operations of some TNCs,
a part of the foreign trade of those countries became a part
of the intra-firm trade, implying that along with exports,
there was also a simultaneous increase in imports.

As a result of the role of internationally owned firms in
foreign trade, the use of transfer prices made the effect of
the FDI operations less transparent and national welfare
effects more limited.

By the mid-1990s, it was still not clear to what extent the
TNCs had contributed to high value-added export production in
the transition economies.

While the activities of TNCs are opening up new career
possibilities for talented young experts in their
international network, the positive employment effects from
green-field investments have been more than counterbalanced by
the negative effects of rationalization in firms taken over by
the foreign entrepreneurs.

"Downsizing, rather than an increase in employment, could
be observed as a result of the spread of foreign firms."

And while it would be too early to draw any conclusions on
the overall income effects of FDI, "the available sporadic
data indicate its contribution to the growing income

The TNCs in the former socialist countries of Europe have
a much stronger bargaining position, based on their market
power, than the private or state-owned firms of host
countries. The power of the TNCs has also been greater than
that of governments which were inexperienced, hit by economic
and social difficulties and functioning under external and
internal constraints after the collapse of the socialist
regimes. The TNCs thus enjoyed special advantages in acquiring
state-owned firms.

In the past, Simai observes, in the industrial countries
too, relations between the foreign sector and the national
economy had posed a difficult problem. Even in the 1990s, when
capital movements have become liberalized and the differences
in legal conditions applied to foreign and local enterprises
are disappearing, there are problems with the assimilation and
integration of the TNC subsidiaries.

"Practically no industrial country could develop a unified
liberal policy framework for trade, capital movements,
international entrepreneurship and migration. This is even
more so in the countries which are at a lower level of
development. In addition, the former socialist countries still
have a number of different constraints in the integration of
foreign firms."

And while certain segments of the national economies of the
transition countries may become a part of the internationally
integrated production systems of TNCs, there is a danger of
evolving duality in the economies as a result of the
increasing gap in performance between the foreign sector and
the rest of the economy.

TNCs have proved, Simai concludes, that they, in general,
are themselves not interested in curing sick economies. As
they are primarily motivated by the interests of their system
and not those of the host-country, they may even aggravate
certain "diseases" by taking a large share of the host-country
incomes, facilitating capital flight, overpricing and other
sophisticated tax-evasion practices. And their monopolistic
position in domestic markets may reduce or eliminate the
advantages offered by competition.

Demand for unskilled labour

In his paper on "International Trade, Outsourcing and
Labour," which is also included in the book, Edward Amadeo
notes that there has been an increase in trade flows between
developed and Latin American countries as well as an increase
in FDI since the 1980s. According to the conventional view on
international trade, countries will specialize in the
production of goods which use more intensely, the more
abundant factors of production.

Hence, if unskilled labour is the relatively abundant
factor of production in developing countries, the reduction in
trade barriers and increase in trade flows will tend to
increase the relative demand for labour in favour of unskilled
workers in these countries, thus increasing their relative

Other things being equal, TNCs will invest in countries in
which the cost of labour is lower. And since this condition is
satisfied in developing counties, there would be a tendency
towards relocation of certain industries to developing
countries. Deregulation of labour markets and reduction in the
cost of labour would tend to increase the incentives for TNCs
to invest in developing countries.

Thus, the increase in trade flows and greater penetration
of TNCs in Latin America should increase the relative demand
for unskilled labour, thus increasing their employment

However, evidence so far shows that the trends are in the
opposite direction. Relative wages have moved in favour of the
more skilled workers and the size of the informal sector has
been increasing.

To the extent that the evidence shows a long-term trend, it
seems to imply that there are some other factors affecting
relative wages.

In Amadeo's view, both changes in technology and management
methods may be increasing the relative demand for skilled
labour in developing countries, and in Latin America in

The long-term effects of greater FDI on the structure of
employment and relative wages between skilled and unskilled
workers, and between the formal and informal segments of the
labour market, are still uncertain.

On the one hand, there might be positive effects on the
size of the formal sector associated with greater investments.
But to the extent that these investments have an anti-
unskilled-labour bias (due to technological factors), the
effect on the size of the formal sector and the relative wage
of unskilled workers might be negative, Amadeo adds.

Re-evaluating the Mexican success story

Looking at what he calls the TNC-centric industrialization
process in Mexico, Michael Mortimore, a senior economist at
the Economic Commission for Latin America and the Caribbean
(ECLAC) and author of several studies on TNCs in Latin
America, notes that Mexico is one of the success stories in
Latin America most often cited by institutions promoting the
Washington (neo-liberal) Consensus on economic policy.

But the Mexican experience also shows some worrying trends.
Capital inflows, combined with a decline in the level of
domestic savings and a persistent trend towards revaluation of
the exchange rate, implied a current account deficit (which
ultimately led to the peso crisis in 1994-95).

The Mexican results, both the positive (renewed growth,
capital inflows, increased and diversified exports, and
reduced inflation) and the negative ones (foreign exchange
crisis, trade and current account deficits, and weak capital
formation), are outcomes directly related to the adoption of
neo-liberal policies oriented towards reducing the role of the
state in the economy, Mortimer notes.

Mexico's success in breaking out of the debt crisis of the
1980s and strengthening the international competitiveness of
some leading industrial sectors, such as automobiles and
electric machinery and electronics, makes it a very special

In international trade, its export growth has been
spectacular, and eight of the ten principal Mexican exports to
the OECD are in the list of the 50 most dynamic industrial

But in spite of a higher export propensity, foreign firms'
imports into Mexico also continue to be very significant, and
its foreign trade balance shows a deficit. Mortimer's analysis
is borne out by the performance of the automobile and
electronics sectors.

[The Mortimore analysis of the Mexican experience in the
automobile sector contrasts with the positive, and somewhat
"gushing", assessment in UNCTAD's 1995 World Investment Report
(WIR) of the TNCs' role in restructuring the Mexican
automobile sector. The bibliography in that WIR (which
advocated a multilateral framework on investment) includes
some of the Mortimore studies, but not the one presented at
the WIDER meeting, though some draft manuscript versions had
been available even at that time at the UNCTAD secretariat,
which was having some collaborative projects with ECLAC on

Vehicle producers responded to the liberalization of the
Mexican economy by building modern and internationally
competitive plants. And when the Mexican market collapsed in
the early 1980s, the period coincided with the implementation
of new corporate strategies on the part of US vehicle
producers operating in Mexico.

The FDI in Mexico by the US automobile TNCs was aimed at
defending their national market from import penetration by
Japanese and other producers. General Motors, Ford and
Chrysler came to the conclusion that Mexico could become a
low-cost export platform for entry-level front-wheel-drive
four- and six-cylinder small cars.

The three US manufacturers expanded their Mexican
production and reoriented it towards export. The
transformation of the Mexican automobile industry towards
international competitiveness was the work of the Big Three US

In terms of productivity and quality, the new production
facilities caught up with, and in certain cases surpassed, the
benchmarks of the US auto industry, including the Japanese
transplants operating there.

The Japanese challenge to the US automakers in their own
market led the Big Three to alter their corporate strategies
with regard to entry-level front-wheel-drive small-engine
passenger cars. They sought out lower-cost production sites in
a few select newly industrializing countries, one of the most
important of which was Mexico. In the Mexican case, strategic
asset-seeking and cost-reducing FDI replaced the former
market-seeking FDI.

Another industry which similarly expanded rapidly was the
electrical machinery and electronic equipment industry, where
the abundant supply of relatively high-quality, low-cost
labour was used by North American producers. The growth of
Mexico's electric and electronic equipment industry in the
1990s was largely export-led, mainly in the in-bond assembly
scheme, and this favoured the integration of this industry
into the world economy, particularly the North American one.

But unlike in the case of the Korean auto industry which
progressively integrated national suppliers, the Mexican case
has resulted in the progressive demise of much of the existing
autoparts industry.

The Korean experience in the auto industry proved to be a
much richer learning experience for all involved, while the
Mexican example does not penetrate the national
industrialization process to the same extent.


"The jury is still out," comments Mortimore, "[an] whether
the Mexican example can be considered one of immiserizing
international competitiveness... The concept implies that an
economy gains international competitiveness but it does not
serve to diminish the level of misery which exists in national

"...The Mexican TNC-centric model has enabled many TNCs,
especially US ones, to defend their market shares in their
home markets. However, national Mexican companies for the
most part are not major participants in the most dynamic
industries of international trade. Rather they operate in
generally undynamic sectors such as cement, glass etc."

Commenting on the Mortimore study, and the contrast it
draws between Mexico and the Japanese and Korean experiences
of industrialization, the editors of the volume, Richard
Kozul-Wright and Robert Rowthorn note that though Mortimore
does not draw the parallel, his comments about Mexico "echo
the criticisms often voiced about Malaysia's even more
spectacular TNC-centric development."

Kozul-Wright and Rowthorn also note that the expanding
scope of international production and the accompanying role of
TNCs have introduced new challenges and opportunities for
domestic firms, but there is no guarantee that the benefits
will outweigh the costs or that market forces will
spontaneously generate the desired outcome.

For both economic and political reasons, small countries -
industrial, developing or transitional - are likely to be the
most worried about the potential dangers of globalization,
especially the rise of TNCs against which they have little
bargaining power.

"Indeed, the state remains a pivotal organization able to
bring together social, political and economic assets in such
a way as to provide the vision and coordination needed to
ensure the growth and integration work in a mutually
supportive way." (Third World Economics No. 191,
16-31 August 1998)

Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS)from which the above article first appeared.