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Overview
China’s authoritarian system allows for bold, radical economic reform, but China has attracted FDI largely because of its increasingly credible investment environment as well as its central and local governments’ efforts to overcome constraints on investment. India’s democratic institutions provide more political assurance to foreign investors, but its market became conducive to FDI only when the government adopted more flexible investment policies. Taiwan’s democratic transition shifted its balance of policy credibility and flexibility, which was essential for the nation’s economic takeoff and sustained growth.
Zheng concludes that a more accurate understanding of the relationship between political institutions and FDI comes from careful analysis of institutional arrangements that entail a trade-off between credibility and flexibility of governance.
Product Details
| ISBN-13: | 9780472119042 |
|---|---|
| Publisher: | University of Michigan Press |
| Publication date: | 01/20/2014 |
| Series: | Michigan Studies In International Political Economy |
| Pages: | 266 |
| Product dimensions: | 6.00(w) x 9.10(h) x 1.00(d) |
About the Author
Read an Excerpt
Governance and Foreign Investment in China, India, and Taiwan
Credibility, Flexibility, and International Business
By Yu Zheng
The University of Michigan Press
Copyright © 2014 University of MichiganAll rights reserved.
ISBN: 978-0-472-11904-2
CHAPTER 1
Political Institutions, Governance, and Foreign Direct Investment
On March 22, 2010, Google, the company providing the world's largest web search engine, decided to pull its search service out of China, the largest Internet-using country. Google spokespersons claimed that the company could no longer tolerate the excessive Internet censorship and cyber spying there. A few days later, Rio Tinto, an Anglo-Australian mining giant, was accused of harming China's economic interests. Four of the company's employees were charged with bribery and received harsh sentences, after the initial allegation of stealing state secrets was dropped. Both the European Union Chamber of Commerce in China and the American Chamber of Commerce in China have issued reports complaining about a deteriorating business environment in China (Johnson and Dean 2010).
Meanwhile, Arcelor Mittal, the world's largest steelmaker, faced a severe challenge in India. It had not been able to acquire land for five years for its proposed projects in the mineral-rich states of Jharkhand and Orissa. Instead, its plan for land acquisition spurred massive demonstrations by the tribal community. Armed with the traditional bow and arrow, villagers went head-to-head with the global steel giant and cried, "We may give away our lives, but we will not part with an inch of our ancestral land" (Basu 2010).
These incidents have fueled a global debate about the investment climate in these two vast and booming economies. Although the statistics suggest a more worrisome picture in India, the Indian Express, one of the most influential newspapers of the Indian subcontinent, defended India's investment prospects: "While, the current, and normal, level of social unrest in India might be much higher than in China, there was much less of a risk in India that social unrest could suddenly escalate to the point where the political system itself is vulnerable or foreign investors are forced to re-evaluate their assessment of risks" (May 17, 2011). This claim highlighted an important question of international political economy: what political attributes make a developing country attractive to foreign investors?
Behind this claim stands a large and growing — if more nuanced — literature in political science and related disciplines. The classic literature of political economy emphasizes the critical role of governments' credible commitment for creating a mechanism conducive to the private investment necessary for countries seeking rapid economic growth. Governments' commitments are made credible by self-enforcing institutions, such as constitutions or an independent judiciary, which underlie limited governments (North 1990; North and Weingast 1989). Authoritarian regimes, given the absence of checks and balances, are regarded as unlikely or even incapable of making credible commitments.
Is democracy or autocracy more conducive to foreign direct investment (FDI)? Anecdotal evidence has not provided a definitive answer. Cross-national quantitative studies are equally inconclusive. That China is one of the largest recipients of FDI while it is ruled by an authoritarian leadership challenges the view claiming the superiority of democratic regimes. One may point out China's unusual advantages — its size, high growth rate, and abundant cheap labor — but it is not exceptional as an authoritarian regime that happens to attract a large amount of FDI. Brazil, Argentina, Indonesia, Malaysia, and Vietnam have all been successful in attracting FDI under authoritarian governments. Of course, we can also spot numerous examples of failed authoritarian regimes. Indeed, foreign firms would need tremendous courage to consider investing in Robert Mugabe's Zimbabwe or Kim Jong-un's North Korea.
If a certain type of political regime is more conducive to FDI, how can we explain divergent FDI performances in countries with similar political institutions or similar performance under distinct political institutions? Although finding the answer is difficult, a dichotomous explanation in favor of either political regime can be rejected, for several reasons.
First, there is lack of direct linkage between the political regime and foreign investment. As Fukuyama (2011, 5) points out, "The mere fact that a country has democratic institutions tells us very little about whether it is well or badly governed." Although property rights institutions, the fundamental determinants of investment and output (Acemoglu and Johnson 2005), are endogenous because democratic countries tend to have better protection of property rights, there is a lack of clarity about how such protection, particularly from private trespass, is strengthened by democratic institutions. Foreign firms may pay close attention to regulations and policies relevant to their businesses, but they care little about the political regime beyond the immediate boundaries of their commercial interest.
Second, although foreign firms often engage in herd behavior (i.e., mimicking the investment decisions of other firms) as a consequence of rational attempts by managers to enhance their reputations (Scharfstein and Stein 1990), they do not have the same criteria in assessing investment climate. Foreign firms' perception of a political environment is influenced by their specific preferences, which are likely to be shaped by their industries, asset specificity, and production strategy, that is, whether the primary motivation for FDI is to serve markets abroad (horizontal) or to reduce production costs (vertical) (Williamson 1996; Aizenman and Marion 2004).
Finally, the static typology of political regimes does not correspond to the dynamic changes in governance outcomes. Although FDI has been found to increase in countries that were experiencing smooth democratic transitions (e.g., South Korea, Chile, and Thailand), countries such as China, Vietnam, and India have achieved high investment-driven economic growth without any change in their respective political regimes.
The primary goal of this book is to develop a better understanding of the relationship between political institutions and FDI. I make a two-level argument. First, at the macro level, political institutions entail a fundamental tradeoff between credibility and flexibility, which can both enhance and undermine a country's ability to attract FDI. Making a credible commitment is a crucial — but not the only — institutional factor important to foreign investors. Authoritarian countries attract FDI not despite their political institutions but partly because of their intrinsic advantage of being able to make flexible policy. Second, at the micro level, governments can create specific institutional devices to compensate for the deficiencies of macroinstitutional arrangement. Countries will be more attractive to foreign investors when arbitrary governments signal their credibility more effectively or when rigid governments enhance their flexibility.
In this book, I examine the relationship between political institutions and FDI through the use of cross-national analysis and cases studies of three Asian economies — in China, India, and Taiwan — with a focus on the role of "special economic zones," a microinstitutional innovation, in changing investment policy environment. Despite their distinct political institutions, all three states had seemingly similar successes in attracting FDI and sustaining high economic growth. China and India are the most popular FDI destinations today, and Taiwan was among the most preferred places in the 1970s and 1980s. China has been a communist regime since 1949 and during the entire period of high growth since 1978; India has been a consolidated democracy since 1950; Taiwan was ruled by an authoritarian government during its economic takeoff (1960–70) but experienced a democratic transition during its period of sustained growth (1980–90).
The findings from the subnational statistical analyses and case studies buttress the central argument of this book. China's authoritarian system gave the government the capacity to take bold initiatives in launching radical economic reform, but its success in attracting FDI has been largely due to the increasingly credible investment environment. India's democratic institutions provide more political assurance to foreign investors, but its market became conducive to FDI only when the government adopted investment policies that were more flexible. Taiwan's democratic transition, which also shifted the combination of policy credibility and flexibility, was essential for Taiwan's' transformation of the investment climate during the periods of economic takeoff and sustained growth.
The objective of this chapter is to situate the analysis of the book within the existing debate over the institutional determinants of FDI. After identifying some of the theoretical assumptions on which existing literature is based, I will preview the argument developed in this book. To do so, I will first present the overarching argument. Then I will elaborate the argument through three cases — China, India, and Taiwan — and analyze how the different institutional settings shape the governance outcomes. Finally, I will discuss the study's methods and theoretical contributions.
Existing Literature on Institutions and Investment
The relationship between institutions and private investment has been examined extensively. The classic literature of political economy emphasized the fundamental role of macropolitical institutions in determining the constraints and distribution of de jure political power, which in turn affects politicians' ability to make credible commitments to investors (North 1990; North and Weingast 1989).
The early literature tended to draw a distinction between democratic and autocratic regimes in their ability to make a credible commitment. Authoritarian governments, given the absence of checks and balances, were regarded as unlikely or incapable of attracting foreign investors. Yet the cross-national quantitative analyses did not provide consistent evidence to support a positive relationship between democracy and private investment (Jensen 2003, 2008; Li and Resnick 2003; Blanton and Blanton 2007; Feng 2001; Przeworski et al. 2000; Knack and Keefer 1995; Oneal 1994). Przeworski and Limongi (1993) suggested that the hypothesized correlation between democracy and the security of property rights does not exist.
In recent years, the veto player framework developed a finer-grained distinction between various types of political institutions (Tsebelis 2002; Cox and McCubbins 2001). The ability of governments to make a credible commitment is shaped by the number and preference of veto players, which can come from constitutional arrangements, electoral rules, party systems, or other de jure and de facto checks on the government. Empirical findings have shown that institutions with multiple veto players reduce policy volatility and hence attract more private investment (Henisz 2000a, 2002, 2004; Keefer and Stasavage 2003). Unlike the democracy/autocracy dichotomy, the veto player framework maintains that some authoritarian regimes can also be held accountable at the margin as long as they have more than one veto player, but none of the popular measures of veto players has detected meaningful variations that would allow sufficient analytical leverage to distinguish different authoritarian regimes.
Still, a question arises as to why authoritarian countries appear as capable of attracting FDI as are democratic countries at comparable levels of development. The early developmental state literature emphasized the role of "strong states" in subsequent economic growth (Wade 1990; Haggard 1990) but was criticized for a lack of clarity about precisely how institutions were related to growth (Rodrik 2007). Some recent studies have developed a better understanding of how authoritarian regimes can establish policy credibility beyond what their political institutions would allow (Gehlbach and Keefer 2011; Wright 2008; Keefer and Vlaicu 2008; Gandhi and Przeworski 2007; Acemoglu and Robinson 2006; Haber et al. 2003). There are two distinct and interrelated perspectives.
On the one hand, domestic coalitions among interest groups, rather than political institutions, may be more likely to affect the credibility of a government's commitment. The nature and degree of the divergence of interests will determine the strength and efficacy of institutional constraints. Using historical evidence from sovereign debt repayment by the English and French governments, Stasavage (2002a) argues that although multiple veto players can improve policy credibility, policymakers' preferences are equally fundamental. Without strongly motivated leadership committed to respecting rules, the probability of achieving a credible commitment is minimal even when institutions are present. In other words, authoritarian rulers could be capable of making a credible commitment as long as that commitment is in their own interest.
On the other hand, attracting foreign investors does not require governments to make a credible commitment to all citizens and to secure property rights broadly. Rather, they can exhibit partial credibility by exploiting patron-client networks (Keefer and Vlaicu 2008), institutionalizing the authoritarian ruling party (Gehlbach and Keefer 2011), or offering selective protection of property rights in exchange for some type of economic benefit from a particular group of asset holders (Haber et al. 2003). Building on the logic of political survival (Bueno de Mesquita et al. 2003), this perspective echoes the hypothesis of "bureaucratic authoritarianism" developed by O'Donnell (1988) but has a clearer institutional foundation.
The central message we can take from these studies is that authoritarian governments also have bases of support and need to induce cooperation. But the strength of their capacity to commit is not as broad as that of democratic governments, because of the smaller size of their selectorates and the higher cost of making a commitment.
Other scholars argue that certain institutional arrangements, rather than macropolitical institutions, may be more effective in affecting foreign investors' decisions. Through external delegation, countries inherently lacking institutional constraints could create "commitment institutions" to mitigate the institutional weakness, at least to a certain extent. These institutions might include granting independent authority to regulators (Levy and Spiller 1996), creating binding legislatures (Wright 2008), adopting specific and substantive rules, signing a bilateral investment treaty with investors' home countries (Buthe and Milner 2009; Elkins et al. 2006), joining international organizations (Buthe and Milner 2008), or negotiating schemes for investment-cost sharing (Jensen 2006). These specific institutions would lead to increased external monitoring as well as to rapidly incurred reputation costs, making it less likely for governments to renege on their commitments.
The lack of clear linkage between national political institutions and microlevel special institutions has fueled the study of governance and investment climate (e.g., Kaufmann et al. 2009). Although the concept of "governance," the definition of which varies considerably (Baland et al. 2010), largely remains vague rhetoric, there is increasing agreement among scholars that getting institutions right does not necessarily mean that a developing country will need a full package of democratic institutions to attract FDI and achieve economic growth. Thus, the "second-best" principle has recently gained its popularity (Rodrik 2007; Dixit 2004; Easterly 2002), partly due to the failure of the "Washington Consensus" experiments in Latin American and transition economies. Partial institutional reform, given its relatively low fixed cost and pro-change tendency, may be more conducive to removing the low-equilibrium trap and garnering new investments. Joseph Stiglitz (2002) argues that for developing and transition countries in which imperfect information and an incomplete market may distort investors' incentives and hamper economic growth, government intervention can always improve on market imperfections. Dani Rodrik (2007) goes a step further by arguing that government has a positive role to play in stimulating economic development beyond simply enabling markets to function well.
All of these studies have contributed important insights in understanding institutional diversity and economic governance. Although various governance outcomes are likely to reflect the influences of institutions, finely tuned institutional arrangements do not always produce desirable governance outcomes. Therefore, the task of identifying the causal effects of institutions — that is, what institutional arrangement would motivate and enable governments to take the appropriate initiatives to attract investment and accelerate the growth process — is extremely difficult.
(Continues...)
Excerpted from Governance and Foreign Investment in China, India, and Taiwan by Yu Zheng. Copyright © 2014 University of Michigan. Excerpted by permission of The University of Michigan Press.
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Table of Contents
Acknowledgments ix
Chapter 1 Political Institutions, Governance, and Foreign Direct Investment 1
Chapter 2 Credibility, Flexibility, and International Business Cross-National Evidence 25
Chapter 3 Incentives and Commitment: The Political Economy of Development Zones in China 50
Chapter 4 Local Accountability under Authoritarianism: Evidence from Development Zones in China 77
Chapter 5 Unbundling the Rule of Law in China: Local Lawmaking Power and Private Investment 103
Chapter 6 The Political Economy of Special Economic Zones in India 132
Chapter 7 Democratic Transition, Institutional Innovation, and FDI in Taiwan 159
Conclusion 186
Appendix on Data 201
Notes 205
Bibliography 217
Index 245