23 Things They Don't Tell You About Capitalism

After a high-profile but turbulent cabinet career, marred by two resignations due to suspected corruption scandals, Mandelson quit British politics and moved to Brussels to become European Commissioner for Trade in 2004. Building on the image of a pro-business politician, gained during his brief spell as the UK’s Secretary of State for Trade and Industry back in 1998, Mandelson established a firm reputation as one of the world’s leading advocates of free trade and investment.

So it sent out a shockwave, when Mandelson, who had made a surprise comeback to British politics and become Business Secretary in early 2009, said in an interview with the Wall Street Journalin September 2009 that, thanks to Britain’s permissive attitude towards foreign ownership, ‘UK manufacturing could be a loser’, even though he added the proviso that this was ‘over a lengthy period of time, certainly not overnight’.

Was it a typical Mandelson antic, with his instinct telling him that this was the time to play the nationalist card? Or did he finally cotton on to something that he and other British policy-makers should have realized a long time ago – that excessive foreign ownership of a national economy can be harmful?

Now, it may be argued, the fact that firms have a home-country bias does notnecessarily mean that countries should put restrictions on foreign investment. True, given the home bias, investment by a foreign company may not be in the most desirable activities, but an investment is an investment and it will still increase output and create jobs. If you put restrictions on what foreign investors can do – for example, by telling them that they cannot invest in certain ‘strategic’ industries, by forbidding them from holding a majority share or demanding that they transfer technologies – foreign investors will simply go somewhere else and you will lose the jobs and the wealth that they would have created. Especially for developing countries, which do not have many national firms that can make similar investments, rejecting foreign investment because it is foreign many people believe is frankly irrational. Even if they get only lower-grade activities such as assembly operation, they are still better off with the investment than without it.

This reasoning is correct in its own terms, but there are more issues that need to be considered before we conclude that there should be no restriction on foreign investment (here, we put aside portfolio investment, which is investment in company shares for financial gains without involvement in direct management, and focus on foreign direct investment, which is usually defined as acquisition of more than 10 per cent of a company’s shares with an intent to get involved in management).

First of all, we need to remember that a lot of foreign investment is what is known as ‘brownfield investment,’ that is, acquisition of existing firms by a foreign firm, rather than ‘greenfield investment’, which involves a foreign firm setting up new production facilities. Since the 1990s, brownfield investment has accounted for over half of total world foreign direct investment (FDI), even reaching 80 per cent in 2001, at the height of the international mergers and acquisitions (M&A) boom. This means that the majority of FDI involves taking control of existing firms, rather than the creation of new output and jobs. Of course, the new owners may inject better managerial and technological capabilities and revive an ailing company – as seen in the case of Nissan under Carlos Ghosn – but very often such an acquisition is made with a view to utilizing capabilities that already exist in the acquired company rather than creating new ones. And, more importantly, once your national firm is acquired by a foreign firm, the home bias of the acquiring company will in the long run impose a ceiling on how far it progresses in the internal pecking order of the acquiring company.

Even in the case of greenfield investment, home-country bias is a factor to consider. Yes, greenfield investment creates new productive capabilities, so it is by definition better than the alternative, that is, no investment. However, the question that policy-makers need to consider before accepting it is how it is going to affect the future trajectory of their national economy. Different activities have different potentials for technological innovation and productivity growth, and therefore what you do today influences what you will be doing in the future and what you will get out of it. As a popular saying among American industrial policy experts in the 1980s went, we cannot pretend that it does not matter whether you produce potato chips, wood chips or microchips. And the chance is that a foreign company is more likely to produce potato chips or wood chips than microchips in your country.