Foreign Investment and Government Policy in the Third World

The tragedy at Union Carbide’s plant in Bhopal, India, late in 1984 raises a host of difficult legal, economic and policy issues. The headlines were filled with news of the disaster and of the filing of lawsuits by plaintiffs’ lawyers, including ‘King of Torts’ Melvin Belli, for billions of dollars. Yet most of the attention merely reacted to the events and missed fundamental questions: Why was the plant built? Why did a foreign company have working control? What interests were served by the fact that Indian nationals owned a majority of the equity stock in the subsidiary and that the plant managers were Indians? Should countries accept foreign economic presence only in the form of financial capital, or management or both? Management is often sought because of the need to use foreign managers to train indigenous ones (this process was thought to have been completed at Bhopal). Should such issues affect how investments are regulated in terms of the environment, safety, and other interests?

Key to the overall development of any Third World economy is the pace and pattern of financial sector development.¹ This is especially true in the case of Indonesia. During the colonial days, the domestic financial system was merely an extension of the Dutch banking system and was used almost exclusively as a means of facilitating trade between Indonesia and Holland. Since that time, Indonesia’s financial system has changed markedly. The evolution of the commercial banking system and, particularly, changes in the rules governing foreign involvement in the financial system have been important elements in Indonesia’s national development policies. Today, the financial sector is a mixture of government-owned commercial banks, privately-owned commercial banks, foreign banks, foreign representative offices, a few joint venture finance companies and some state-owned development banks. Also important in Indonesia is an ‘informal’ or grey market financial system, made up of money changers dealing in cash loans and post-dated cheques which are discounted from their face value as a form of credit. While certainly more complex than many developing countries, Indonesia’s financial system remains relatively underdeveloped by comparison with those of Taiwan, Singapore, Hong Kong, and South Korea.² Despite some recent efforts to increase the array of financial instruments, Indonesian savers and investors still have relatively few financial instruments available for investment purposes. Importantly, the government is recognizing the need to improve and to develop further the country’s financial sector.

The Indonesian experience has been part of a larger pattern. In recent decades many Third World countries have sought to reduce the level of foreign influence over their economies. In extreme cases this has resulted in nationalization of foreign-owned industries or companies.¹ More typically, however, local governments have increased local economic autonomy through less draconian measures while still using foreign capital and know-how to their advantage.

During the past twenty years, many Third World countries have attempted to establish local stock markets. Included among these countries are Brazil, South Korea, Malaysia, Mexico, Nigeria, Pakistan, the Philippines, Singapore, Taiwan and Thailand.¹ These attempts have produced mixed results,² but in virtually all cases the evolution of securities markets has had only a limited impact in intermediating financial resources for the Third World economic development. The reasons most often cited are lack of investor confidence due to poor information and insider manipulation, the high risk, and market imperfections that have hindered the allocation of capital to the most efficient companies.

As the interdependence of the world’s economies has increased, the tension between governments and corporations has also increased. Where multinational corporations have been central to a nation’s economy, the tension has been particularly apparent. This is especially true in Third World countries, where the storm over multinationals has been most evident.