Global Policy Forum

Foreign Investment Regulation in Historical Perspective


By Ha-Joon Chang*

Third World Network
March, 2003

1. Introduction

During the last several years, the developed countries have been stepping up their pressure to install a multilateral investment agreement that prevents countries from controlling TNC investment activities, and possibly the activities of portfolio investors. The first major attempt along this line was the proposal to introduce a Multilateral Investment Agreement (MIA) through the OECD in the late 1990s. When this failed, the issue was momentarily shelved, but it has come back with a vengeance as one of the so-called Singapore issues of the WTO. There is now a move to initiate the negotiation for a multilateral investment agreement at the forthcoming Cancun meeting of the WTO in September 2003.

The developed countries argue that, in the same way all of them had used free trade policy in order to become rich, they all have benefited from policies welcoming foreign investors and therefore that the developing countries should do the same. In their view, those developing countries that are objecting to free trade agreements and liberal investment agreements are making a futile attempt to go against the current of history – how do they think they can succeed in economic development without the tried and tested means of free trade and free investment?

In this paper, I will show that this view is fundamentally misguided, by examining the historical experiences of a number of today's developed countries the USA, the UK, France, Germany, Finland, Ireland, Japan, Korea, and Taiwan, and showing that in general they have not used liberal policies towards foreign investment before they became highly developed. Then I will draw lessons from these historical experiences for today's developing countries' foreign investment regulation and for the discussion on a potential WTO agreement on investment.

2. The USA

From its early days of economic development to the First World War, the USA was the world's largest importer of foreign capital. The eminent business historian Mira Wilkins plainly states that during the 1875-1914 period, the USA was "the greatest debtor nation in history" despite its rise as one of the major lender countries in the international capital market at the end of this period (Wilkins, 1989, p. 144). Given the country's position as a net importer of capital, there was naturally a lot of concern with foreign investment. While many Americans accepted the necessity of foreign investment and some sought it out enthusiastically, there was also a widespread concern with "absentee management" (Wilkins, 1989, p. 563), and, further, foreign domination of the American economy.

The fear of foreign investment was not confined to the "radicals". For example, the Bankers' Magazine of New York remarked in 1884: "It will be a happy day for us when not a single good American security is owned abroad and when the United States shall cease to be an exploiting ground for European bankers and money lenders. The tribute paid to foreigners is … odious … We have outgrown the necessity of submitting to the humiliation of going to London, Paris or Frankfort [sic] for capital has become amply abundant for all home demands" (Bankers' Magazine, no. 38, January, 1884, cited in Wilkins, 1989, p. 565). According to the same magazine, the great majority of Americans believed it was "a misfortune to have its [the country's] public, corporate, and private securities abroad" (no. 33, April, 1879, cited in Wilkins, p. 915, note 67).

Even Andrew Jackson (the seventh President of the USA, 1829-37), a well-known advocate of small government and therefore something of a hero among American free-marketeers today, amply displayed anti-foreign feelings. He famously vetoed the renewal of the federal government charter for the country's second quasi-central bank, the (second) Bank of the USA, largely on the ground that "many of its stockholders were foreigners" (Wilkins, pp. 61-2, p. 84; Garraty & Carnes, 2000, pp. 255-8). When he exercised his veto in 1832, he said: "should the stock of the bank principally pass into the hands of the subjects of a foreign country, and we should unfortunately become involved in a war with that country, what would be our condition? …. Controlling our currency, receiving our public moneys, and holding thousands of our citizens in dependence, it would be far more formidable and dangerous than the naval and military power of the enemy. If we must have a bank … it should be purely American." (as cited in Wilkins, 1989, p. 84).

Others would go even further. On the eve of the de-chartering of the Second Bank of the USA (henceforth SBUSA), the Jackson government moved federal government deposits to other banks. One of these banks, the Manhattan Bank, was foreign-owned but, not being a federal-chartered bank like the SBUSA, it did not ban foreign shareholders from voting (which was the case with federally-chartered banks – see below). Therefore, Niles' Weekly Register, one of the leading magazines of the time, found it scandalous that "IN THIS BANK THE FOREIGN STOCKHOLDERS VOTE [capitals original]!" (no. 45, 16 Nov, 1833, cited in Wilkins, 1989, p. 84). Another article that appeared two years later in this magazine (no. 48., 2 May, 1835) neatly sums up the dominant American feeling at the time – "We have no horror of FOREIGN CAPITAL—if subjected to American management." (cited in Wilkins, 1989, p. 85, italics and capitals original).

In order to ensure that foreign investment does not lead to loss of national control in the key sectors of the economy, a large number of federal and state legislation were enacted in the USA since its Independence until the mid-20th century, when it became the world's top economic nation. And as the main sectors that received foreign investments during this period were in finance, shipping, and natural resource extraction (agriculture, mining, logging), the legislation were concentrated in them.

2.1 Federal legislations
(a) Navigation
One of the first acts of the new Congress upon Independence as an imposition in 1791 of differential tonnage duties between national and foreign ships (Wilkins, 1989, p. 44). Similarly, a navigation monopoly for US ships for coastwise trade imposed in 1817 by the Congress (Wilkins, 1989, p. 83). This continued until WWI (Wilkins, 1989, p. 583).

(b) Finance
In the financial sector, legislative provisions were made in the charter for the country's first quasi-central bank, the first Bank of the USA (henceforth FBUSA) in 1791 to avoid foreign domination. Only resident shareholders could vote and only American citizens could become a director. And thanks to these provisions, the Bank could not be controlled by foreigners, who owned 62% of the shares by 1803 and 70% by 1811. Despite this, when its charter was up for renewal in 1811, the Congress did not re-charter the Bank "in large part owing to fears of foreign influence" (Wilkins, 1989, pp. 38-9, p. 61; the quote is from p. 61). A similar provision against voting by foreign shareholders was made for the SBUSA, when it was given the federal charter in 1816 (Wilkins, 1989, p. 61).

In addition, the 1864 National Bank Act also required that the directors of national (as opposed to state) banks had to be Americans (Wilkins, 1989, p. 455) – this lasted even after the introduction of the Federal Reverse System in 1913 (Wilkins, 1989, p. 583). This meant that "foreign individuals and foreign financial institutions could buy shares in U.S. national banks if they were prepared to have American citizens as their representatives on the board of directors" And therefore "[t]hat they could not directly control the banks served as a deterrent to investment" (Wilkins, 1989, p.l 583).

(c) Land
From the early days of independence, many state governments barred or restricted non-resident foreign investment in land (Wilkins, 1989, p. 45). However, a particularly strong feelings against foreign land ownership developed, following the frenzy of land speculation by foreigners in the frontier areas in the 1880s. In 1885, the New York Times editorialised against "an evil of considerable magnitude—the acquisition of vast tracts of land in the Territories by English noblemen" (NYT, 24, Jan., 1885).

Reflecting such feelings, the federal Alien Property Act (1887) and 12 state laws were enacted during 1885-95 with a view to control, or sometime even altogether ban, foreign investment in land (Wilkins, 1989, p. 235). An 1885 resolution passed by the New Hampshire legislature read: "American soil is for Americans, and should be exclusively owned and controlled by American citizens" (Wilkins, 1989, p. 569). The 1887 federal Alien Property Act prohibited the ownership of land by aliens or by companies more than 20% owned by aliens in the territories (as opposed to the states), where land speculation was particularly rampant (Wilkins, 1989, p. 241). However, it must be noted that due to the lack of disclosure rule on ownership, it was practically not possible to check upon the identities of all the corporate owners and therefore the law was not totally effective (Wilkins, 1989, p. 582).

(d) Natural Resources
There was less hostility towards foreign investment in mining than towards that in land, but still considerable ill-feelings existed (Wilkins, 1989, pp. 572-3). Federal mining laws in 1866, 1870, and 1872 restricted mining rights to US citizens and companies incorporated in the USA. In 1878, a timber law was enacted, permitting only US residents to log on public land (Wilkins, 1989, p. 581). Similarly to the Alien Property Act, these laws were not totally effectual against foreign corporate investment, due to the difficulty of checking company ownership (p. 129). In 1897, the Alien Property Act was revised to exempt mining lands.

(e) Manufacturing
Restrictions on foreign investment in manufacturing were relatively rare, as such investment was not very important until the late 19th century, by which time the USA managed to build up a robust position in many sectors of manufacturing behind the world's highest tariff barrier. However, there were still concerns about the behaviour of TNCs in manufacturing, especially transfer pricing. For example, a US government investigation in the wake of the First World War expressed grave concerns that the German TNCs were avoiding income tax payment by understating their net earnings by charging excessively for technology licenses granted to their American subsidiaries (Wilkins, 1989, p. 171). Interesting in relation to FDI in manufacturing was the 1885 contract labour law, which prohibited the import of foreign workers. This applied also to national companies, but it obviously affected foreign firms more, especially in relation to the import of skilled workers (Wilkins, 1989, pp. 582-3). Many TNCs did not like the law because it restricted their ability to bring in skilled workers from their headquarters.

2.2. State Legislations
Some of the state laws were even more hostile to foreign investment than the federal laws (Wilkins, 1989, p. 579). In addition to the state laws banning or restricting non-resident foreigners' investment in land that had existed from the early days of independence, 12 state laws were enacted during 1885-95 with a view to control, or sometime even altogether ban, foreign investment in land (Wilkins, 1989, p. 235). In addition, there were number of state laws that taxed foreign companies more heavily than the American ones. There were also a notorious Indiana law in 1887 withdrawing court protection from foreign firms (p. 579). The New York state government took a particularly hostile attitude towards foreign investment in finance, an area where it was rapidly developing a world-class position (a case of infant industry protection, one may say). A New York law in 1886 required foreign insurance companies to have 2.5-times minimum paid-up capital of American companies (p. 580), while another law required that all certified public accountants (CPAs) to be American (p. 580). The New York state also instituted a law in the 1880s that banned foreign banks from engaging in "banking business" (such as taking deposits and discounting notes or Bills). The 1914 banking law banned the establishment of foreign bank branches (Wilkins, 1989, p. 456). These laws proved very burdensome on foreign banks. For example, the London City and Midland Bank (the then world's third largest bank, measured by deposits) could not open a New York branch, when it had 867 branches worldwide and 45 correspondent banks in the USA alone (Wilkins, 1989, p. 456).

On the whole, federal government condoned anti-foreign state laws. Wilkins (1989) writes: "The State Department and Congress did give an implicit green light to anti-foreign state government laws. Neither was responsive to intermittent diplomatic inquiries from London, requesting the federal government to muzzle state legislators. The Secretary of State John Hay replied (in 1899) in a very standard manner to one such request that was related to discriminatory taxes against foreign fire insurers: ‘Legislation such as that enacted by the State of Iowa is beyond the control of the executive branch of the General Government'" (p. 584).

2.3. Summing-up
To sum up, in contrast to its strong support for foreign investment liberalisation today, when it was a capital-importing country, the USA had all kinds of provision to ensure that foreigners invest in the country but do not control its economy. For example, the US federal government had restrictions on foreigners' ownership in agricultural land, mining, and logging. It discriminated foreign firms in banking and insurance, while prohibiting foreign investment in coastal shipping. It demanded that all directors of national banks have to be American citizens, while depriving foreign shareholders of voting rights in the case of federally-chartered banks. It also prohibited the employment foreign workers, thus implicitly disadvantaging foreign investors that wanted to import skilled labour from their home countries.

At the state level, there were even more restrictions. In addition to restrictions on land ownership, many states taxed foreign companies more heavily and some even refused them legal protection. Many state legislation in the financial sector were even more discriminatory. Some states imposed more strict capital base requirements on foreign financial institutions, and some even totally banned entry into certain financial industries (e.g., New York state laws banning foreign bank entry). The federal government condoned such laws and refused to take action against state governments even when there were pressures from foreign investors and governments to do so.

3. The More Advanced Large European Countries – the UK, France, and Germany

Until the early 20th century, the UK, France, Germany (together with the Netherlands and Switzerland) were mostly suppliers of capital to the less developed countries, including the USA, Canada, and Russia. Therefore, during this period, the main concern for these countries, especially the UK since the late 19th century when it was rapidly losing its industrial supremacy, was how to control "excessive" outward foreign investment rather than how to control inward foreign investment.

In the few decades following the end of the Second World War, however, controlling inward foreign investment became a major new challenge for these countries. If they were to close the newly-emergent technological gap with the USA, they had to accept American investment, especially FDI (Servan-Schreiber, 1967, is the most prominent work of the time on this issue).

Until the 1980s, given that these countries did not adopt laws explicitly discriminating against foreign investors except in sensitive areas (e.g., defence, cultural industries), the most important element in their control of foreign investment was their foreign exchange control, which gave their governments the ultimate say in foreign investment. Of course, this does not necessarily mean that their governments used the control to the same effect. For example, the UK, even before the adoption of its pro-FDI policy under Mrs. Thatcher, took a more permissive attitude towards FDI and rarely used its foreign exchange control law (1947-79) to influence FDI, except in its early years (Young et al., 1988), whereas France was more active in the management of its FDI flows. However, there were also other mechanisms of control.

First, in all of these countries (except the UK after the 1980s), the significant presence of SOEs in key sectors in the economy has acted as an important barrier to FDI. Also, when not technically SOEs, some of their key enterprises have had significant government ownership – for example, the state government of Lower Saxony is the biggest shareholder of Volkswagen, with a 20% share ownership. Moreover, even when privatizing some of the SOEs in the 1980s, the French government was careful to ensure that control of these enterprises remain French by reserving a significant proportion of shares for "hard core" (noyau dí»r) institutional investors close to the government (Dormois, 1999, p. 79).

Second, in the case of Germany, the difficulty of hostile take-over, due to the presence of close industry-bank relationship as well as to the power of labour exercised through the supervisory board, has acted as a significant barrier to FDI. Given that in the UK, where hostile take-over is easy, the bulk of FDI has consisted of "brownfield" investment based on take-overs rather than "greenfield" invesment, FDI in Germany could have been considerably higher than what it has been without the above-mentioned defence mechanisms against hostile take-over.

Third, all these countries, including the ostensibly FDI-friendly UK, have used informal performance requirements for key FDI projects. For example, in the UK, since the 1970s in certain industries, a variety of informal "undertakings" and "voluntary restrictions" were used to regulate foreign investment (Young et al., 1988). These were mostly, although not exclusively, targeted at Japanese companies, especially in automobile and electronics. According to Young et al. (1988), "[i]t is widely believed that [all investments by Japanese electronics giants in the 1970s and the early 1980s – Sony I 1974, Matsushita in 1976, Hitachi and Mitsubishi in 1979, Sanyo and Toshiba in 1981] were subject to some form of voluntary restraint agreement with the Department of Industry on local sourcing of components, production volumes and exporting, but details are not publicly available. Several of the companies reported particular difficulties in implementing local procurement policies and in the slow build up of production which they were allowed" (p. 224). This prompted one observer to remark in 1977 that "every Japanese company which has so far invested in Britain had been required to make confidential assurances, mainly about export ratios and local purchasing" (Financial Time, 6 December, 1977, as reported in Young et al., 1988, p. 223). When Nissan established a UK plant in 1981, it was forced to procure 60% of value added locally, with a time scale over which this would rise to 80 per cent (Young et al., 1988, p. 225). Also "[t]here is much evidence that successive ministers in the Department of Trade and Industry have put pressure on [Ford and GM] to achieve a better balance of trade, although details in timing and targets are not available" (p. 225). Young et al. observed in 1988 that "limited use of performance guidelines (if not explicit requirements) are effectively now regarded as part of the UK portfolio" (p. 225).

To sum up, the UK, France, and Germany did not have to control foreign investment until the Second World War, as they were capital-exporting countries before that. However, when they were faced with the challenge of upsurge in American investment after the Second World War, they used a number of formal and informal mechanisms to ensure that their national interests are not hurt. Formal mechanisms included foreign exchange control and regulations against foreign investment in sensitive sectors like defence or cultural industries. At the informal level, they used mechanisms like the SOEs, restrictions on take-over, and "undertakings" and "voluntary restrictions" by TNCs in order to restrict foreign investment and impose performance requirements.

4. Poorer European Countries – Finland and Ireland

In this section, we examine Finland and Ireland – two countries that were among the poorest in Europe until a generation ago but have become star performers through very different policies towards foreign investment, the former very restrictive and the latter very permissive (although not as hands-off as many people believe).

4.1. Finland
Finland is a severely overlooked case of economic miracle of this century. Until the late 19th century, Finland was one of the poorest economies in the Europe. However, it is today one of the richest. This owes to its impressive performance throughout the 20th century. According to the authoritative statistical work by Madison (1989), among the 16 largest rich countries of today, only Japan (3.1%) achieved a higher rate of annual per capita income growth than that of Finland (2.6%) during the 1900-87 period (p. 15, table 1.2). Norway tied with Finland in the second place, and the average for all 16 countries was 2.1%.

What is even less well known than Finland's impressive growth performance is the fact that it was built on the basis of a regime of draconian restrictions on foreign investment – arguably the most restrictive in the developed world. As a country that had been under foreign rule for centuries and as one of the poorest economies in Europe, Finland was naturally extremely wary of foreign investment and duly implemented measures to restrict it (all information in following paragraphs are from Hjerppe & Ahvenainen, 1986, pp. 287-295, unless otherwise noted). Already in 1851, it established a law prescribing that any foreigner, Russian nobles excepted, had to obtain permission from the Tsar, then its ultimate ruler of the country, to own land. Added to this were the 1883 law that subjected mining by foreigners to license, the 1886 ban on banking business by foreigners, and the 1889 ban on building and operation of railways by foreigners. In 1895, it was stipulated that the majority of the members on the board of directors of limited liability companies had to be Finnish. All these laws remained valid until at least the mid-1980s.

After independence from Russia, restrictions on foreign investment were strengthened. In 1919, it was stipulated that foreigners had to get special permission to establish a business and guarantee in advance the payment of taxes and other charges due to the central and the local states. In the 1930s, a series of laws were passed in order to ensure that no foreigner could own land and mining rights. It was also legislated that a foreigner cannot be a member of the board of directors or the general manager of a firm. Companies with more than 20% foreign ownership were officially classified as "dangerous companies" and therefore foreign ownership of companies was restricted to 20%. As a result, while there was a considerable foreign borrowing, there was little FDI during this period, a pattern that persisted at least until the 1980s.

There was some liberalisation of foreign investment in the 1980s. Foreign banks were allowed for the first time to found branches in Finland in the early 1980s. Foreign ownership ceiling of companies was raised to 40% in 1987, but this was subject to the consent by the Ministry of Trade and Industry (Ballek & Luostarinen, 1994, p. 17). A general liberalisation of foreign investment was made only in 1993, as a preparation for its EU accession (, p. 1).

4.2. Ireland
Ireland is often touted as an example showing that a dynamic and prosperous economy can be built on the basis of a liberal FDI policy. Its impressive economic performance, especially during the recent period, earned it the titles of "Celtic Tiger" or "Emerald Tiger", following the "miracle" economies of the "East Asian Tigers" (Korea, Taiwan, Singapore, and Hong King).

After the exhaustion of early import substitution possibilities and the ensuing industrial stagnation in the 1950s, Ireland shifted its industrial policy radically from an inward-looking to an outward-looking strategy (for further historical backgrounds, see O'Malley, 1989). The new policy regime focused on encouraging investment, especially in export industries, through financial incentives. The main incentive schemes used were: (1) capital investment grant, which required the recipient firms to be internationally competitive; (2) exemption of tax for profits earned from export sales above the 1956 level (the law had no new recipients since 1981 and was abolished in 1991); and (3) accelerated depreciation (O'Malley, 1999, pp. 224-5). In addition to encouraging investment, these schemes were also intended to reduce regional disparity by offering higher grant rates for investment in less developed regions. Additionally, the government established industrial estates in poor regions at its own expenses (O'Malley, 1999, p. 225).

While this policy regime did not favour foreign enterprises per se, it had a certain degree of bias for foreign enterprises, as they typically had higher export orientation. The existence of this bias towards TNCs, however, should not be interpreted as the same as having a totally laissez-faire approach towards FDI. According to the 1981 US Department of Commerce survey, The Use of Investment Incentives and Performance Requirements by Foreign Governments, 20% of US TNC affiliates operating in Ireland reported the imposition of performance requirement, in contrast to the 2-7% in other advanced countries – 8% in Australia and Japan, 7% in Belgium, Canada, France, and Switzerland, 6% in Italy, 3% in the UK, and 2% in Germany and the Netherlands) (Young et al., 1988, pp. 199-200). However, it is true that the investment grants disbursed during this period was rather unfocused and therefore did not deliver the best value for money (O'Sullivan, 1995; O'Malley, 1999).

The post-1958 industrial policy ran out of steam by the late 1970s. FDI continued to be mostly in low-value-added sectors, while they failed to create many linkages with indigenous firms. By the mid-1980s, there developed a sense of crisis in the country, when employment in indigenous firms experienced a rather sharp decline (about 20%) since the peak of 1979, while the employment in foreign firms more or less stagnated since the late 1970s (O'Sullivan, 1995; O'Malley, 1999; Barry et al., 1999).

As a result, there was another policy shift in the mid-1980s towards a more targeted approach, especially towards the development of indigenous firms. The new policy regime was set out most clearly in the 1984 White Paper on Industrial Policy (O'Malley, 1999, p. 228). According to O'Malley (1999), the White Paper recognised that "there were limits to the benefits that could be expected from foreign investment and that the relatively poor long-term performance of indigenous industry called for a greater focus of addressing that problem. More specifically, policy statements since 1984 have referred to a need for policy towards indigenous industry to be more selective, aiming to develop larger and stronger firms with good prospects for sustained growth in international markets, rather than assisting a great many firms indiscriminately. Policy was intended to become more selective, too, in the sense of concentrating state supports and incentives more on correcting specific areas of disadvantage or weakness which would be common in indigenous firms (but not so common in foreign-owned firms), such as technological capability, export marketing and skills. It was intended to shift expenditures on industrial policy from supporting capital investment towards improving technology and export marketing" (p. 228; italics added).

As a result, after the mid-1980s, "the award of [capital investment] grants was increasingly dependent on firms having prepared overall company development plans. With a view to obtaining better value for state expenditure, the average rate of capital grant was reduced after 1986, performance-related targets were applied as conditions for payment of grants, and there was the beginning of a move towards repayable forms of financial support such as equity financing rather than capital grants." (O'Malley, 1999, p. 229; italics added). An increasing share of government grants was directed to capability-upgrading activities (e.g., R&D, training, management development) rather than simple physical investment (Sweeney, 1998, p. 133). Moreover, the government started explicitly targeting industries into which they want to attract FDI – emphasis was given to industries like electronics, pharmaceutical, software, financial services, and teleservices (Sweeney, 1998, p. 128).

Following the re-direction of FDI policy, there was a rise in high-quality FDI, with stronger linkages to indigenous firms. Largely as a result of this, the economy started to boom again. Manufacturing employment, which fell by 20% during 1979-87, rose by 13% during 1988-96, in large part due to increase in FDI but also due to the improvement in the performance by indigenous firms (O'Malley, 1999, p. 230).

4.3. Concluding Remarks
Finland and Ireland are arguably among the most impressive cases of industrial transformation in the second half of the 20th century in Europe. However, their respective policies towards foreign investment could not have been more different, at least until Finland's accession to the EU in 1993 – Finland basically blocking any significant foreign investment, while Ireland aggressively seeking it out.

The comparison of these two polar cases raises two important points. The first is that there is no one-size-fits-all foreign investment policy that works for everyone. Finland built its economic miracle under arguably one of the world's most restrictive policy regimes vis-í -vis foreign investors, while Ireland benefited from actively courting and working with TNCs. The second is that, however "liberal" a country may be towards foreign investment, a targeted and performance-oriented approach works better than a hands-off approach, which is recommended by the developed countries today. Even in the case of Ireland, a combination of carrots and sticks has been used vis-í -vis the foreign investors since the early days, and it was only when it got the balance between the two right that the country started to truly benefit from FDI.

5. The East Asian Countries

The role of foreign investment, especially FDI, in East Asia has been a lively subject for debate. In this section, we examine the policies used by the three main countries in the region, Japan, Korea, and Taiwan, and try to draw lessons from them.

5.1. Japan
Japan's restrictive stance towards FDI is well known. From the Meiji period on, it has tried its best to discourage FDI and go for technology licensing whenever feasible. Even during the first half of the 20th century, when Japan took a more permissive stance towards FDI than either before or after – for example, the American TNCs dominated the automobile industry during the time – FDI remained small in scale and much of it remained joint ventures (Yoshino, 1970, p. 346)

Between the Second World War and the mid-1960s, when there was some liberalisation of FDI, FDI policy regime remained extremely restrictive. In particular, before 1963, foreign ownership was limited to 49%, while in some "vital industries" FDI was banned altogether. Consequently, FDI accounted for only 6% of total foreign capital inflow between 1949 and 1967 (Yoshino, 1970, p. 347).

There was some relaxation in policy over time, but it was a very slow and gradual process. After 1963, that foreign ownership of over 50% was allowed, even in some hitherto prohibited "vital industries" (Yoshino, 1970, p. 349). However, "each investment application had to go through individual screening and was rigorously examined by the Foreign Investment Council" (p. 349). And "the criteria for screening foreign investment were stated with characteristic vagueness, giving the government officials and the Foreign Investment Council considerable latitude""(p. 350).

In 1967, FDI was further liberalised. However, even this was highly restrictive (the following details are from Yoshino, 1970, pp. 361-3). The 1967 liberalisation "automatically" allowed a maximum of 50% foreign ownership in 33 industries (so-called "Category I industries"), but this was on the condition that: (1) the Japanese partner in the joint venture must be engaged in the same line of business as the contemplated joint venture, while one Japanese partner must own at least 1/3 of the joint venture; (2) the Japanese representation on the board of directors must be greater than the proportion of Japanese ownership in the venture; and (3) there should be no provision that the consent of a particular officer or a stockholder be required to execute corporate affairs – a hardly "automatic" approval! And these were industries where the Japanese firms were already well established and therefore not attractive to foreign investors (e.g., household appliances, sheet glass, cameras, pharmaceuticals, etc.), as proven by the fact that "more than a year went by before the first joint venture was established" (Yoshino, 1970, p. 363). In the 17 "Category II industries", 100% foreign ownership was allowed, but these were industries where the Japanese firms were even more securely established (ordinary steel, motorcycles, beer, cement, etc.). And importantly, in both Categories, " brownfield" FDI was not allowed.

Further liberalisation in 1969 added 135 and 20 industries to Categories I and II, This round of liberalisation deliberately included a number of attractive industries in order to diffuse foreign criticisms, but they were mostly unattractive to foreigners. Some strategic industries (esp., distribution, petrochemical, and automobiles) were considered as possible candidates for FDI liberalisation, but in the end the proposal was rejected. A hardly surprising decision, when the total output of the Japanese industry (which was already the second largest in the world) was less than half that General Motors, whose annual sales were larger than Japan's national budget, while the total outstanding shares of Toyota Motors at current market value was only about one-fifth of the annual profit of General Motors (Yoshino, 1970, pp. 366-7).

The highly restrictive policy stance has been maintained in subsequent periods despite gradual liberalisation of FDI at the formal level. Like in Germany and many other European countries, FDI was further constrained by the existence of informal defence mechanisms against hostile takeover, especially the cross-shareholding arrangements that lock up 60-70% of the shares in friendly hands (major lending banks, related enterprises). Consequently, Japan was arguably the least FDI-dependent outside the socialist bloc. Between 1971-90 (the post-95 data are not available, but there is no indication that it has drastically changed), FDI accounted for only about 0.1% of total fixed capital formation in the country (data from UNCTAD, various years). The developed country average was 3.5% for the 15-year period before the late-1990s merger boom (that is, 1981-95).

5.2. Korea
While Korea has not by any means been hostile to foreign capital per se, it clearly preferred, if the situation allowed it, to it under "national" management, rather than relying on TNCs (the following heavily draws from Chang, 1998; for some more details, refer to Koo, 1993). According to Amsden (1989), only 5% of total foreign capital inflow into Korea between 1963 and 1982 (excluding foreign aid, which was important until the early 1960s but not beyond) was in the form of FDI (p. 92, table 5). Even for the 1962-93 period, this ratio remained a mere 9.7%, despite the surge in FDI that followed liberalisation of FDI policy in the mid-1980s (Lee, 1994, p. 193, table 7-4).

The Korean government designed its FDI policy on the basis of a clear and rather sophisticated notion of what are the costs and benefits of inviting TNCs, and approved FDI only when they thought the potential net benefits were positive. The Korean government's 1981 White Paper on Foreign Investment provides a fine specimen of such policy vision (see EPB, 1981). This White Paper lists various benefits of FDI such as investment augmentation, employment creation, industrial "upgrading" effect, balance of payments contribution, technology transfer, but is also clearly aware of its costs arising from transfer pricing, restrictions on imports and exports of the subsidiaries, "crowding out" of domestic investors in the domestic credit market, allocative inefficiencies due to "non-competitive" market structure, retardation of technological development, "distortion" of industrial structure due to the introduction of "inappropriate" products, and even the exercise of political influences by the TNCs on the formation of policies (EPB, 1981, pp. 50-64). It is interesting to note that this list includes more or less all the issues identified in the academic debates.

The policies towards TNCs employed by Korea have had a number of elements, but the most important was clearly the restrictions on entry and ownership. Initially, until the early 1970s, when the level of FDI was low, the government was quite willing to allow 100% foreign ownership, especially in the assembly industries in free-trade zones which were established in 1970. However, as the country tried to move into more sophisticated industries, where development of local technological capabilities is essential, it started restricting foreign ownership more strongly (Lee, 1994, pp. 187-8).

To begin with, there were policies that restricted the areas where TNCs could enter. Until as late as the early 1980s, around 50% of all industries and around 20% of the manufacturing industries were still "off-limits" to FDI (EPB, 1981, pp. 70-1). Even when entry was allowed, the government tried to encourage joint ventures, preferably under local majority ownership, in an attempt to facilitate the transfer of core technologies and managerial skills.

Even in sectors where FDI was allowed, foreign ownership above 50% was prohibited except in areas where FDI were deemed to be of "strategic" importance, which covered only about 13% of all the manufacturing industries (EPB, 1981, p. 70). These included industries where access to proprietary technology was deemed essential for further development of the industry, and industries where the capital requirement and/or the risks involved in the investment was very large. The ownership ceiling was also relaxed if: (i) the investment was made in the free trade zones; (ii) the investments were made by overseas Koreans; or (iii) the investment would "diversify" the origins of FDI into the country – namely, if the investment is from countries other than the USA and Japan, which had previously dominated the Korean FDI scene. For details, see EPB (1981, pp. 70-1). As a result, as of the mid-1980s, only 5% of TNC subsidiaries in Korea were wholly-owned, whereas the corresponding figures were 50% for Mexico and 60% for Brazil, countries which are often believed to have had much more "anti-foreign" policy orientations than that of Korea (Evans, 1987, p. 208).

Policy measures other than the ones concerning entry and ownership were also used to control the activities of TNCs in accordance with national developmental goals. Firstly, there were measures to ensure that the "right" kinds of technology were acquired in the "right" terms. The technology that were to be brought in by the investing TNCs was carefully screened and checked whether they were not overly obsolete or whether the royalties charged on the local subsidiaries, if any, were not excessive. Secondly, those investors which were more willing to transfer technologies were selected over the others which were not, unless they were too far behind in terms of technology. Thirdly, local contents requirements were quite strictly imposed, in order to maximise technological spill-overs from TNC presence. One thing to note, however, is that the targets for localisation was set realistically, so that they would not seriously hurt export competitiveness of the country – in some industries they were more strictly applied to the products destined for the domestic market.

The overall result was that, together with Japan, Korea has been one of the least FDI-dependent countries in the world. Between 1971-95, FDI accounted for less than 1% of total fixed capital formation in the country (data from UNCTAD, various years), while the developing country average for the 1981-95 period (pre-1980 figures are not available) was 4.3%. FDI began to be liberalised since the mid-1980s and was drastically liberalised following the 1997 financial crisis. This was not only because of the IMF pressure but also because of the decision, right or wrong, by some key Korean policy-makers that the country cannot survive unless it allows its firms fully to be incorporated into the emerging international production network. Whether their decision was right remain to be seen.

5.3. Taiwan
Taiwan took a similar attitude towards FDI to that of Korea, and has used all the measures that Korea used in order to control FDI (see Wade, 1990, pp. 148-56, and Schive, 1993, for further details). However, Taiwan's FDI policy has had to be somewhat more tempered than that of Korea for two reasons. First of all, due to the relative absence of large domestic private sector firms, which could provide credible alternatives to (or joint-venture partners with) TNCs, the Taiwanese government had to be more flexible on the ownership question. Therefore, in terms of ownership structure of TNC subsidiaries Taiwan was somewhere in between Korea and Latin America, with 33.5% of the TNC subsidiaries (excluding the ones owned by overseas Chinese) being wholly-owned as of 1985 (Schive, 1993, p. 319). Second, during the 1970s, when the diplomatic winds blew strongly in favour of China, Taiwan made efforts to host big-name TNCs, especially from the USA, by offering them exceptional privileges (e.g., guaranteed protection against imports) in order to strengthen its diplomatic position (Wade, 1990, pp. 154-5).

Despite these constraints, "[f]oreign investment proposals have been evaluated in terms of how much they open new markets, build new exports, transfer technology, intensify input-output links, make Taiwan more valuable to multinationals a foreign investment site and as a source for important components, and enhance Taiwan's international political support" (Wade, 1990, p. 150). The 1962 Guidelines on foreign investment, which was the backbone of Taiwan's FDI policies limited FDI to "industries which would introduce new products or direct their activities toward easing domestic shortages, exporting, increasing the quality of existing products, and lowering domestic product prices." (Wade, 1990, p. 150, f.n. 33). This meant that, like in Korea, the favoured types of FDI kept changing with the changes in the country's economic and political conditions. For example, after an encouragement during the 1960s, FDI in labour-intensive industries were discouraged or prevented in the 1970s (Wade, 1990, p. 151).

First of all, although in a weaker form than in Korea, foreign ownership was restricted. There was, in particular, a restriction on the extent to which foreign investors can capitalise on their technology. In the case of a joint venture, the technology could not be valued at more than 15% of the TNC's equity contribution (Wade, 1990, p. 152).

Second, local content requirements were extensively used, although as in Korea, they were typically less tough for export products (Wade, 1990, pp. 151-2 for details on the operation of local content requirements). In some cases, the government gave approval for investment on the condition that the TNC helps its domestic suppliers to upgrade their technology (Wade, 1990, p. 152). Third, export requirements were also widely used (Wade, 1990. P. 152). This was initially motivated by the foreign exchange consequences of FDI but it was kept even after Taiwan had no more foreign exchange shortage, because it was seen as a way to "insure that the [foreign] company brings to Taiwan a technology advanced enough for its products to compete in other (generally wealthy Western) markets" (Wade, 1990, pp. 152).

The overall result was that, although somewhat more dependent on FDI than were Japan or Korea, Taiwan was one of the less FDI-dependent countries in the world. Between 1971-99, FDI accounted for only about 2.3% of total fixed capital formation in the country (data from UNCTAD, various years), while the developing country average for the 1981-95 period (pre-1980 figures are not available) was 4.3%.

5.4. Concluding Remarks
Like the USA in the 19th century, the three largest East Asian economies have tried to use foreign capital under national management as much as they can, and consequently have used extensive controls on foreign investment in terms of ownership, entry, and performance requirement, throughout their developmental period. Especially Japan and Korea (until recently) relied very little on FDI, while even Taiwan, the most FDI-friendly among the three countries, was below interanational average in its reliance on FDI.

Their approach was decidedly "strategic" in the sense that, depending on the role of the particular sectors in the overall developmental plan of the time, they applied very liberal policies in certain sectors (e.g., labour-intensive industries established in free trade zones in Korea and Taiwan) while being very restrictive in others. It goes without saying that therefore the same industry could be, and have been, subject to relatively liberal treatments at some point but became subject to more strict regulations (and vice versa), depending on the changes in the external environment, the country's stage of development, and the development of the indigenous firms in the industries concerned. Especially the experience of Korea and Taiwan, which provided extensive financial incentives to TNCs investing in their countries while imposing extensive performance requirements, show that FDI bring the most benefit when carrots are combined with sticks, rather than when either carrots or sticks alone are used.

6. Conclusion: Lessons for Today

I have shown in my book, Kicking Away the Ladder, that, when they were in "catching-up" positions and trying to establish their industries against the competition from the more efficient producers of the more advanced countries, virtually none of today's developed countries pursued free trade policy that they are so eager to impose on the developing countries nowadays (Chang, 2002, chapter 2). An examination of their policies in relation to foreign investment reveals the same picture. In short, when they were net recipients of foreign investment, all of today's developed countries had imposed strict regulation of foreign investment.

Almost all of them restricted entry of foreign investment. Very often, the entry restrictions were directly imposed, ranging from a simple ban on entry into particular sectors to the allowance of entry on certain conditions (e.g., ceilings on foreign ownership, requirements on the terms of technology transfer).

However, in some cases the scope for foreign investment was also restricted through informal mechanisms that prevented hostile acquisitions and takeovers by foreign investors ("brownfield" investment). First of all, they achieved this through the presence of SOEs or at least the holding of significant minority shares by the in government) in enterprises in the key sectors – for example, 20% of Volkswagen shares is owned by the state government of Lower Saxony. And even when privatising the SOEs, some of these governments, notably that of France, made it sure that a controlling stake was held by friendly "core" shareholders. Others, such as the USA and Finland, even restricted the entry of foreign investment by regulating the forms of corporate governance - they explicitly required, at least in some key sectors, that all members of board of directors have to be citizens and that non-resident foreign shareholders cannot vote, which obviously discouraging potential foreign investors, who were not given control that is commensuarate to their ownership status.

And even when entry was allowed, there were many performance requirements. Some of the requirements were put in place for balance of payments reasons, such as export requirement or ceilings on licensing fees, but most of them were put in place in order to ensure that the locals pick up advanced technologies and managerial skills from their interaction with foreign investors, either through direct transfer or through indirect spill-over. Local contents requirement and explicit requirements for technology transfer are the most obvious ways to ensure this. Some countries, such as Taiwan, have taken this logic further and explicitly required foreign investors to help even the local suppliers for technology upgrading. Ban on majority foreign ownership or the encouragement of joint venture are also ways to encourage the transfer of key technologies and managerial skills. A ban on the employment of foreigners, as used in the USA in earlier times, can also increase the chance that skills are directly transferred to the locals.

Of course, as in the case of trade policy, the exact strategies that were used to regulate foreign investment varied across countries, ranging from the very welcoming (but not laissez-faire and increasingly selective over time) strategy of Ireland to the very restrictive strategy of Finland, Japan, Korea, and the 19th-century USA in certain sectors (especially finance and navigation). In other words, there was no "one-size-fits-all" model of foreign investment regulation.

However, one commonality between them is that they took a strategic approach to the issue of foreign investment regulation. This meant that different sectors could be subject to different policies even at the same point in time. For example, Korea and Taiwan applied liberal policies towards FDI in labour-intensive industries while applying very restrictive policies towards FDI in the more technologically advanced industries, where they wanted to build local technological capabilities. Also, over time, with changes in their economic structure and external conditions, their policy stances changed. Ireland's successful shift from a rather permissive and unfocused foreign investment policy to a focused and selective one in the mid-1980s is an excellent example of this. In other words, none of today's developed countries pursued policies that are blindly welcoming to foreign investment, contrary to what many of them recommend to today's developing countries. In light of these lessons, we can say that the current proposals made by the developed countries in the WTO in relation to foreign investment regulation go directly against the interests of the developing countries.

Especially, the notion of "national treatment" makes it impossible for developing country governments to regulate foreign investment in a manner that is congruent with their national interests. Given that their national interests are unlikely to coincide all the time with the interests of the foreign investors, the imposition of national treatment requirement will lead to a serious reduction in the development capacity of the developing country government policies. All countries should be allowed to deploy whatever policy that they see fit for their national interests.

Another problem with the "national treatment" principle is that those who support national treatment for investors do not do the same in relation to migrant labourers. If they are going to support national treatment for capital, they should support it for labour as well. If there should be no nationality for capital, there should be no nationality for labour either.

When one points out these problems, the typical response from the liberalisers is that they want to restrict policy freedom of the developing countries even if sometimes there may be cases when such restriction restricts their ability to pursue national interest, because they want to "protect" the developing countries from harming themselves by adopting bad policies, such as trade protection and regulation of foreign investment. However, even if we accept that these are indeed bad policies (a proposition which is not supported by historical evidence nor by economic theories), it is curious that these free-market economists who are so much against "paternalistic" government intervention at the national level on the ground that people should have the freedom to choose (and by implication the freedom to make mistakes) at the same time want to impose policies against the will of the recipients out of "paternalistic" concerns. Either they are so blinkered by their free-market ideology that they do not see the contradiction, or they are trying to "kick away the ladder" which they used in order to climb up to the top.

About the Author: Ha-Joon Chang is on the faculty of Economics and Politics at the University of Cambridge

(1)Even until as late as 1914, when it had caught up with the UK and other leading nations of Europe, the USA was one of the largest net borrowers in the international capital market. The authoritative estimate by Wilkins (1989) puts the level of US foreign debt at $7.1 billion, with Russia ($3.8 billion) and Canada ($3.7 billion) trailing in distance (p. 145, table, 5.3). Of course, at that point, the USA, with its estimated lending at $3.5 billion, was also the 4th largest lending country, after the UK ($18 billion), France ($9 billion), and Germany ($7.3 billion). However, even after subtracting its lending, the US still has a net borrowing position of $3.6 billion, which is basically the same as the Russian and the Canadian one.
(2) However, the Second Bank of the USA was only 30% owned by foreigners, as opposed to 70% in the case of the First Bank of the USA, its predecessor (1789-1811) (Wilkins, 1989, p. 61).
(3) Wilkins says (1989, p. 84, n. 264) that similar remarks were made by politicians in the debate surrounding the renewal of the charter of the first Bank of the USA.
(4) At the time the territories were North Dakota, South Dakota, Idaho, Montana, New Mexico, Utah, Washington, Wyoming, Oklahoma, and Alaska. The Dakotas, Montana, and Washington in 1889 and Idaho and Wyoming in 1890 and Utah became sates in 1896, thus stop being subject to this Act.
(5) The 1866 law said that "[t]he mineral lands of the public domain … are hereby declared to be free and open to exploration by all citizens of the United States and those who have declared their intention to become citizens, subject to such regulations s may be prescribed by law, and subject also to the local customs or rules of miners in the several mining districts" (Wilkins, 1989, p. 128).
(6)According to the authoritative study by the IMF published in 1984, the average share of SOE sector in GDP among the industrialised countries as of mid-1970s was 9.4%. The share was 10.3% for West Germany (1976-7), 11.3% for the UK (1974-7), and 11.9% for France (1974) – all above this average.
(7) During the 1970s and the 1980s, Germany's FDI as a share of Gross Domestic Capital Formation (of course, the two numbers are not strictly comparable) just 1-2%, whereas the corresponding figure ranged between 6-15% in the UK. The figures are calculated from various issues of UNCTAD, World Investment Report.
(8) The 16 countries are, in alphabetical order, Australia, Austria, Belgium, Canada, Denmark, France, Finland, Italy, Japan, the Netherlands, Norway, Sweden, Switzerland, West Germany, the UK, and the USA.
(9) Despite the massive external shock that it received following the collapse of the Soviet Union, which accounted for over one-third of its international trade, Finland ranked at a very respectable joint-5th among the 16 countries in terms of per capita income growth during the 1990s. According to the World Bank data, its annual per capita income growth rate during 1990-99 was 2.1% (same with that of the Netherlands), exceeded only by Norway (3.2%), Australia (2.6%), and Denmark and the USA (2.4%).
(10) From the 12th century until 1809, it was part of Sweden, then it existed as an autonomous Grand Duchy in the Russian empire until 1917.
(11) Interestingly, the government investment-promotion agency, Invest in Finland, emphasises that "Finland does not ‘positively' discriminate foreign-owned firms by giving them tax holidays or other subsidies not available to other firms in the economy" (the same website, p. 2).
(12) Interestingly, according to McCulloch & Owen (1983, pp. 342-3) the same survey reveals that over one-half of all foreign subsidiaries in Korea and Taiwan benefit from some form of investment incentive. This is high even by the standards of the developed countries, which were in the 9-37% range reported in table 6.1 of Young et al. (1988, p. 200; Japan 9%, Switzerland 12%; Canada and France 18%; Germany 20%; Belgium, 26%; Italy 29%; UK 32%; Australia 37%). Given that Korea and Taiwan are countries that were also infamous for imposing tough performance requirements (see below), this piece of evidence, together with the Irish example, suggests that both carrots and sticks are needed for a successful management of FDI.
(13) In light of the fact that Ireland was already a country with high level of performance requirement for TNCs before these changes (see above), it seems reasonable to conclude that performance requirement for the recipients of state grants (domestic or foreign) must have become even greater.
(14) For example, the Korean government chose in 1993 the Anglo-French joint venture (GEC Alsthom), organised around the producer of French TGV, as the partner in its new joint venture to build the country's fast train network. This was mainly because it offered more in terms of technology transfer than did its Japanese and German competitors who offered technologically superior products (Financial Times, 23 August 1993).
(15) For example, the 1962 Guidelines subjected industries such as refrigerators, air conditioners, transformers, televisions, radios, cars, motorcycles, tractors, and diesel engines to local content requirements (Wade, 1990, pp. 150-1, f.n. 33).

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