Multinational Enterprises, Foreign Direct Investment and Growth in Africa: South African Perspectives (English)

Multinational Enterprises, Foreign Direct Investment and Growth in Africa

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Bernard Michael Gilroy • Thomas Gries Willem A. Naude Editors

Multinational Enterprises, Foreign Direct Investment and Growth in Africa South African Perspectives With 31 Figures and 22 Tables

Physica-Verlag A Springer Company

Series Editors Werner A. Miiller Martina Bihn Editors Prof. Dr. Bernard Michael Gilroy Prof. Dr. Thomas Gries Department of Economics University of Paderborn Warburger StraBe 100 33098 Paderborn [email protected] [email protected] Prof. Dr. Willem A. Naude Director of WorkWell Research Unit People, Policy and Performance North West University Private Bag X6001 Potchefstroom 2520 South Africa [email protected]

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ACKNOWLEDGEMENTS

This publication is the result of a research project, supported by the South African National Research Foundation (NRF) entitled "Entrepreneurial Networks, Human Skills and Multinational Firms in Labour Market Adjustments to Globalisation". The financial assistance of the National Research Foundation: Division for Social Sciences and Humanities towards this research is hereby acknowledged. Opinions expressed and conclusions arrived at are those of the authors and are not necessarily to be attributed to the National Research Foundation. The authors are also grateful to the Southern African-German Chamber of Commerce and Industry and the German Business Group at KPMG, Johannesburg for their assistance and advice, as well as the many German firms in South Africa that participated in the study. A particular word of thanks is due to Professor Klaas Havenga, former Dean of the Faculty of Economic and Management Sciences from North-West University, and Professor Karl-Heinz Schmidt of Paderborn University, whose farsightedness in stimulating co-operation between the two universities across two continents not only resulted in this research project and publication, but also in a formal collaboration agreement between Paderborn University and North-West University that was signed in May 2001. This book is dedicated to them. All views contained in this paper are that of the authors alone.

Willem Naude, Thomas Gries & Bernard Michael Gilroy POTCHEFSTROOM, SOUTH AFRICA PADERBORN, GERMANY August 2004

CONTENTS

INTRODUCTION B. M. Gilroy, T. Gries, W. Naude

1

Part I Africa in the Global Economy 1 ON GLOBAL ECONOMIC GROWTH AND THE CHALLENGE FACING AFRICA T. Gries, W. Naude

7

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs T. Gries

37

3 THE DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN AFRICA W. Krugell

49

4 THE GLOBAL INTEGRATION OF AFRICA: The EU-SA Free Trade Agreement and German MNEs in South Africa W. Naude, W. Krugell, N. Bauer

73

Part II Multinational Enterprises in Africa 5 THE CHANGING VIEW OF MULTINATIONAL ENTERPRISES AND AFRICA B. M. Gilroy

101

6 GERMAN MULTINATIONALS IN AFRICA B. M. Gilroy, N. Bauer

155

VIII

CONTENTS

7 OBSTACLES FACING GERMAN ENTERPRISES IN SOUTH AFRICA B. M. Gilroy et al

197

8 COMPETITIVE INTELLIGENCE IN A FOREIGN ENVIRONMENT: GERMAN AND CANADIAN FIRMS COMPARED J. Calof, W. Viviers

209

Part III Labour Market Adjustment, Foreign Direct Investment and Human Resource Development 9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT: A Theoretical Analysis with Heterogeneous Labour T. Gries, S. Jungblut

229

10 HUMAN RESOURCE DEVELOPMENT: A SINE QUA NON FOR FOREIGN DIRECT INVESTMENT IN SOUTH AFRICA W. Naude, W. Krugell

247

11 CONCLUSIONS B. M. Gilroy, T. Gries, W. Naude

279

APPENDIX

285

ABOUT THE CONTRIBUTORS

303

INTRODUCTION B. M. GILROY, T. GRIES and W. NAUDE

How can Africa, the world's most lagging region in economic development, benefit from globalisation and achieve high and sustained economic growth rates so as to achieve the international development goal of reducing the number of its inhabitants in poverty by 50% by 2015? In this we proceed from the standpoint that Africa needs much greater investment by multinational enterprises (MNEs) to improve its competitiveness, to develop its comparative advantages and fast-track growth through the positive spill-over effects associated with the activities of global firms. The challenge for African countries at the beginning of the 21 st Century is how to be a more desirable destination. However, the relationship between foreign direct investment (FDI), the behaviour of MNEs and economic growth in Africa may not be well understood. For instance, despite the fact that Africa's returns on investment averaged 29 percent since 1990 (exceeding that of countries like Japan, the US and UK), Africa has gained merely 1 percent of the global FDI flows. This book is based on a research project aimed to better understanding the reasons for this and asks the question: How can Africa be a more desirable location for MNEs? Much of the current research emphasis in the international research community has been on the macro-economic policy conditions for African growth. Only recently, mainly due to household surveys designed to track poverty (e.g. in Ghana) and the work of the World Bank's Regional Programme on Enterprise Development (RPED) to understand how firm-level behaviour is affected by trade liberalisation did our knowledge of the microfoundations of growth in Africa improve. However, whilst household surveys and surveys of African firms are immensely insightful, in a rapidly globalising world economy where MNEs play a dominant role it is necessary to combine insights from household and firm-level surveys with the role and impact of MNEs in Africa. To do this the current study integrates three currents of economic research, namely from the literature on (endogenous) economic growth, convergence

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B. M. GILROY, T. GRIES and W. NAUDE

and regional integration, the explanations for Africa's poor growth and the growing understanding of the role of MNEs in a global economy. We develop a model of human skills, foreign direct investment and catching-up that could be relevant for Africa. The empirical side of the analysis is based on an econometric study of the determinants of FDI in Africa as well as a detailed firmlevel survey of 31 German firms in South Africa that were conducted in 20001. In addition to expanding the knowledge of MNEs in Africa, and identifying the constraints on German firms in South Africa, this study also expands the understanding of the geography of MNEs in general. The behaviour and contribution of MNEs in Africa has perhaps not been well understood in the theoretical literature and this study is an attempt to rectify this shortcoming.

A SOUTH AFRICAN PERSPECTIVE In attempting to answer the difficult question raised in the previous paragraph, we will be taking a South African perspective in the sense that this book is based on a joint research project between the Universities of Paderborn in Germany and North-West University in South Africa. German MNEs have been investing in South Africa for well over a century and South Africa is one of the top five destinations for FDI on the African continent. South Africa provides a particularly fruitful viewpoint from which to study the inflows of FDI by MNEs into Africa. Firstly, it is one of the few African countries that have significantly liberalised its current and capital accounts over the past five years, and achieved a remarkably stable macro-economic position. Easy access, possibilities for profit repatriation and macro-economic stability together with the country's good physical and financial infrastructure suggest therefore that it should be at the forefront of receiving inflows of FDI. However, this has not been the case, and the one unfulfilled requirement in the new government's "Growth, Employment and Redistribution" (GEAR) macro-economic strategy has been the inability to achieve sufficient inflows of FDI. In chapter 10 of this book, we detail the South African experience with FDI inflows in the context of a model that links human capital with FDI inflows. Although this is a South African viewpoint, the implications for the rest of Africa could be argued to be very valid as it emphasises the importance of certain specific micro-foundations for growth such as adequate human capital. 1

Germany provides almost 40 percent of South Africa's imports. There are around 560 German firms in South Africa employing more than 65 000 people. Most of these enterprises can be identified to operate in the secondary sector especially in the machinery, electronic, chemical, pharmaceutical, automobile and metal production sectors. Also important are some 90 SMEs in these sectors, followed by 68 businesses operating in the tertiary sector. The average German firm has been operating in South Africa for 22 years.

INTRODUCTION

3

The South African viewpoint is not only of interest to the rest of Africa. It may also contribute to the current concerns in OECD countries about the implications of trade liberalisation and globalisation for employment growth and employment diversion. The Economic Journal devoted its 1998 Policy Forum to trade and labour market adjustment, noting the marked increases in unemployment and wage differentials between skilled and unskilled labour. Concerns about trade and labour markets have become a "preoccupation" in the OECD and developing countries alike since "with increasing capital mobility and technology diffusion, the quantity and quality of domestic labor forces are ever more important determinants of comparative advantage". Particularly in Germany, globalisation had resulted in firms raising their competitiveness through innovation, with less employment opportunities (especially amongst lower-skilled occupations) being created.

CHAPTER OUTLINE This book contains three broad sections with 10 chapters and a concluding chapter that summarises the main findings. Part 1 identifies the need in Africa for higher levels of FDI inflows in order to catch up with the rest of the world. A model is provided for understanding the roles of FDI in catching-up. In this model, that will be refined in section three (chapter 9) to allow the employment impact of FDI to be studied, the roles of technological upgrading, innovation and human capital formation are emphasised. Section one also investigates the determinants of FDI in Africa through an econometric model and concludes by studying how greater openness in African economies can be established through free trade agreements with higher-income countries. This type of openness is argued to be good for FDI. Part 2 describes the theory of MNEs and provides an examination of the role of MNEs in economic growth through technology and skills transfers and a broad investigation of the role of German MNEs in Africa. Specifically, the historical background and influences of colonialism upon the international production strategies of MNEs in Africa is discussed with a special focus on German MNEs and their activities in South Africa. In this section, the results from the survey of German firms in South Africa are analysed with reference to the large body of existing research on economic growth and multinationals studied in section one and two. The role of German MNEs in South Africa is also examined to determine the behaviour with respect to training, innovation and outsourcing. It is found that German MNEs have an important role in South Africa in terms of employment, innovation, transfers and spillovers but that most of these firms, especially medium-sized firms, are subject to significant constraints. These constraints relate mainly to the labour market,

4

B. M. GILROY, T. GRIES and W. NAUDE

and for that reason section three deals with human capital and labour market adjustments to globalisation. Part 3 approaches the contribution of MNEs and FDI in Africa and South Africa from the crucially important point of human capital and labour market adjustments. The impact of globalisation on labour markets in South Africa is modelled and the human resource development requirements for FDI to lead to positive job creation is analysed.

Part I

Africa in the Global Economy

ON GLOBAL ECONOMIC GROWTH AND THE CHALLENGE FACING AFRICA T. GRIES*1 and W. NAUDE2 1 2

University of Paderborn, Germany [email protected] North-West University, South Africa EBNWANOpuknet. puk. ac. za

1.1 INTRODUCTION Africa remains the world's poorest region, both in absolute and relative terms, at the dawn of the 21 st century. The final decades of this century had been a decade of lost growth for much of the countries of Africa3.The prediction of neoclassical growth theory that poorer countries such as Africa might "catch up" - i.e. converge in per capita income terms with richer countries, has proven over-optimistic. Indeed, most African countries have fallen behind during the 1980s and 1990s. By 1997 average per capita incomes in Africa (outside South Africa) were only US $1045 (expressed in real terms of purchasing power) (Gelb, 1999). On average, real per capita GDP did not grow in Africa over the 1965 - 1990 period, while, in East Asia and the pacific, per capital GDP growth was over 5 percent (Easterly & Levine, 1997). During the 1980s the decline in per capita GDP was 5 percentage points below the average for all low-income developing countries. As the decline accelerated during the 1990s, the gap widened to 6.2 percentage points (Collier & Gunning, 1999). In light of the significant contributions made to economic growth theory by the "endogenous growth" literature the purpose of this chapter is to utilize the insights from that literature, as well as more empirical insights from the literature on Africa's economic performance to attempt to answer two related questions. Firstly, can African countries attain sufficiently high economic growth rates to catch up in per capita income terms with other developing countries? If so, what are the policy changes required to achieve these growth rates? The answers to these questions will also throw light on the extent to which policies aimed at "globalising" African economies are appropriate.

*Some of this material has been previously presented in Welfens, Addison, Audretsch, Gries, Grupp (1999), pp.41-72. 3 The notable exceptions are Botswana and Mauritius.

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T. GRIES and W. NAUDE

In section 2 the problem of Africa's falling behind is illustrated with reference to global patterns of economic growth. Section 3 is an attempt to integrate economic growth theory and the empirical literature on Africa's economic performance in order to identify the determinants of Africa's potential for catching up. Section 4 concludes.

1.2 GLOBAL ECONOMIC GROWTH AND DIVERGENCE A peculiar characteristic of world economic development is the variety of average growth rates across countries during the latter half of the 20*^ century. Figure 1.1 shows the distribution of average growth rates for a sample of 123 countries over the period from 1960 to 1992. Since the figure covers a period of thirty years the variety in average growth indicates substantially different growth regimes. The lowest average growth rate is -2.2, the highest 7.3, and the mean is 1.9 percent. The difference of roughly 10 percentage points between the highest and lowest average growth rate indicates the heterogeneity of growth experience across nations over the last three decades. Only 51 countries, about 41 percent, have growth rates in between one percentage point above or below the mean. For 14 countries the average growth rate is even negative - most of which are African countries. Roughly 16 percent of the economies were not able to increase their income per capita in absolute terms.

number of countries

'Xk %

h.

-3%to -2%to -1%to 0%to1% 1%to2% 2%to3% 3%to4% A"/< -2% -1% 0% Source: SUMMERS and HESTON (1993), Penn World Table 5

3 6% 6%to7% 7%to8%

Fig. 1.1. Average Growth Rates (1960-92) Apart from growth rates the level of income per capita is another important indicator to consider. If a country with a lower income level has a higher

1 GLOBAL GROWTH & CHALLENGE FACING AFRICA

9

growth rate than another country with a higher income level, both economies will converge. The idea of convergence and divergence is extensively used in recent empirical and theoretical studies on growth. In most studies two different concepts of convergence are considered, J-convergence and /3-convergence. For additional definitions of concepts see Quah (1993). If there is a negative correlation between the average growth rate and the initial income per capita, ß -convergence will occur. In this case economies with lower income levels tend to grow faster than rich ones. <5-convergence is said to occur, if the dispersion of income per capita within a group of countries tends to fall over time. Both definitions are related, since /?-convergence is a necessary condition for 5-convergence. average growth rate 1960-1992 0,08 7

1

Club 3 0,06

0,04

Club2

Club4

tClub 1

0,02

>.. •' . / ••Club5

• *

0 400

600

-0,02

800

1000

income I percapita 1200 1 9 6 0 ' intern. — j prices

-0,04 Source: SUMMERS and HESTON (1993), Penn World Table 5

Fig. 1.2. Average Growth Rate of Income vs. Initial Income per Capita Figure 1.2 plots the 1960 level of income per capita against the average rate of growth over the period 1960 to 1992. There seems to be a lack of correlation between the initial level of income and the average rate of growth. The nonappearance of (absolute) convergence for broad samples of countries is now widely accepted in the empirical literature (see Fuente, 1997, for a detailed discussion). Not all countries will eventually converge to the same steady state. Therefore a further refinement has proved to be useful, the distinction between absolute and conditional convergence. Absolute convergence means that all economies are able to reach the same level of income and productivity no matter what initial condition they have. Conditional convergence means that a process of catching up occurs only within a group of countries characterized by similar initial conditions. Thus, only countries or regions with

10

T. GRIES and W. NAUDE

comparable fundamentals will approach similar levels of income per capita and productivity. Countries with different fundamentals will diverge to different steady states. In referring to Africa's ability to catch up or not, this paper is referring to conditional converge. This requires that African countries be clubbed together according to initial per capita incomes, similarly as is done by Baumol (1986). Using the initial income per capita and the average growth rates given in figure 1.2, countries that are close together in the scatter diagram will form a club. Therefore, economies of a specific club will have similar developments of the level of income per capita. Regardless on how these countries have formed clubs there will always be countries that do not belong to any of these clubs. The figure shows that countries with average growth in between zero and four percent can be grouped into at least four additional subgroups. Altogether a total of six groups can be identified: Club 1, "the income elite", consist of the leading countries which have the highest initial income per capita in 1960. The members include Australia, Luxembourg, New Zealand, Sweden, Switzerland and the USA. The average growth rate of these countries is about 2% (for New Zealand it is lower). The economies from Club 2, "the industrialized catching up countries", have a lower initial income per capita, but a higher average growth rate than the leading elite. Thus, the income levels of these economies tend to converge to the leading countries. Typical members are Canada, (West) Germany, Netherlands, France and Italy. Countries from the remaining four clubs have similar initial income levels, but are distinguished according to their average growth rates. Club 3, "the strongly catching up countries", has the highest average growth rate. Typical members are the newly industrialized countries (NICs), like Korea, Hong Kong, and Taiwan, or countries like Japan, Malta, and Portugal. The economies of Club 4, "the slowly catching up countries", still have a higher average growth rate than the leading economies, but they are not as dynamic as the NICs. This club includes countries such as Tunisia, Syria, Turkey and Brazil. Economies of clubs 5 and 6 have lower average growth rates than the leading elite and hence, tend to diverge. Most African economies fall into these two clubs. Countries of Club 5, "the slowly falling behind countries", have positive average growth rates, but less than two percent. In this club are African countries such as Cameroon, Congo, and Kenya. Finally, mainly African economies like Central Africa Republic, Haiti, Mali, Niger, Zaire, and Zambia have negative growth rates and form Club 6, "the strongly falling behind countries". These economies diverge not only in relative terms, but also in absolute terms.

1 GLOBAL GROWTH & CHALLENGE FACING AFRICA

11

As a first stylized fact it can be stated that the industrialized countries (Club 1 and Club 2) and newly industrialized countries (Club 3) have a tendency to converge. The first view suggests that poorer economies of these clubs have higher growth rates than richer economies. A number of empirical studies confirm that for these countries the conditional convergence hypothesis holds (see e.g. Sala-I-Martin (1996), Quah (1996) or Fuente (1997)). The lower a country's income per capita the higher is the expected growth rate. But, it has to be emphasized that the evidence for -convergence is strongly dependent on the chosen group of countries (Fuente, 1997). Using data for 16 countries like Madison (1987) a strong negative correlation between the average growth rate of the economy and the initial income per capita can be found. This does not hold though for a less homogeneous group of 23 countries suggested by De Long (1988). Using the latter sample, the situation is less obvious as the correlation between the average growth rate and the initial income is rather weak. But, it has to be emphasized that the negative correlation between the initial income level and the average growth rate for the sample of 31 countries that form the clubs 1 to 3 is very clear.

1.3 UNDERSTANDING AFRICA'S DIVERGENCE Why do African countries tend to be either members of club 5 or club 6? To offer a satisfactory explanation, an encompassing theory is needed to explain the complete variety of growth processes of different countries or clubs of countries. This section utilizes traditional and new growth theories to explain the characteristics of the global growth process, and judge the relevance thereof for Africa given the rising consensus on the empirics of Africa's economic performance. 1.3.1 The Traditional &: Augmented Solow-Model The traditional neo-classical growth theory of the Solow (1956, 1957), Swan (1956) type regarded technological progress as exogenously given. Technologies are equally available without costs in every country. As a result global convergence is predicted. Countries are expected to converge to steady states determined by the rate of technological progress, savings and population growth. Testing the traditional Solow model Mankiw, Romer and Weil (1992) found that the effects of the saving rate and population growth are overestimated. Further, the traditional model is not able to explain observable differences in the level and growth rate of income across countries unless unreasonably high capital shares are used. Thus, the predictions of traditional neo-classical growth theory do not correspond with the stylized features of the global growth process.

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Therefore, Mankiw, Romer and Weil (1992) introduced a new interpretation. They augmented the standard Solow model by including accumulation of human capital. The emphasis to include human capital is not new. Kendrick (1976) estimated that more than half of the total capital stock of the USA in 1969 consisted of human capital. Introducing human capital Mankiw, Romer and Weil (1992) show that the extended model provides a good explanation of the differences in the countries economic performance. Due to human capital the impact of the saving and population growth rate decrease. Or, to be more precise, if human capital accumulation is included and countries have different rates of accumulation and population growth, the implications of this extended Solow model cannot be rejected easily by the empirical facts. For a diagnosis of Africa's poor economic growth performance, the above theoretical contributions suggests that Africa's endowment of human capital and the investment rate in African countries, seem to be important factors determining growth opportunities. With reference to figure 2 it can be established that the "catching-up" countries of club 3 do have high endowments of human capital and high investment rates while falling behind countries tend to have low human capital and low investment rates. Considering the extent of human capital and fixed investment in Africa, it is firstly clear, from public expenditure data, that public investment in human capital, as a share of potentially productive government expenditure to GDP, is high in Africa. It would thus appear that the provision of education services has not been markedly worse than elsewhere. Africa has a lower stock of education than other regions, but a faster rate of growth of the stock. However, in many cases in Africa the implementation of education policies is deficient. One cause is that many policies are never implemented. When they are, wage expenditure (e.g. on teacher salaries) are prioritised over non-wage recurrent expenditure, to the detriment of delivery (Collier & Gunning, 1999). Secondly, regarding fixed investment in Africa, it is stated by Collier and Gunning (1999) that in order to achieve higher economic growth African countries ought to raise their investment rates. They state (p.42) that, "there is evidence that both a lack of investment response and bounce back are currently important. While the growth rates of the African reformers are currently similar to pre-crisis East Asia, investment rates are around 9 percentage points lower". Several empirical studies in labor economics suggest that human and real capital are poor substitutes in the production process. In a survey on human capital Hamermesh (1986) states: "Perhaps the most consistent finding is that non production workers (presumable skilled labor) are less easily substitutable for physical capital than are production workers (unskilled labor). Indeed, a number of the studies find that non-production workers and physical capital are p-complements. This supports Rosen (1968) and Griliches (1969) results

1 GLOBAL GROWTH & CHALLENGE FACING AFRICA

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on capital-skill complementary hypothesis" (Hamermesh 1986). Later studies also correspond with these findings. Barro (1991) reports that investments in education and physical capital are positively correlated. In various studies, e.g. by Barro (1991), De Long and Summers (1991) or Levine and Renelt (1992) it has been established that the significance of education in growth regressions is reduced when investment in physical capital and other elements are included. Therefore Fagerberg (1994) concludes that countries should not invest in either education or physical capital, but in both assets. There may be evidence that in many African countries the type of physical and human capital investments made do not achieve or result in better complementarity between human and physical capital. The share of potentially productive government spending to GDP in Africa is high, but service delivery is inefficient. The case of deficient education services has been discussed as part of the lack of human capital in Africa. Physical infrastructure in Africa is also lacking in quality and quantity. In many cases the price of infrastructure is high which increases private cost, discouraging growth. A possible explanation of the deficiency of public services is firstly a lack of social capital. In other words, when low levels of civil liberties are found - as in many African countries - ordinary people are denied a channel of popular protest when public service performance worsens. When considering social-political indicators 4 such as measures of corruption, quality of bureaucracy, enforceability of contracts, civil wars, ethno-linguistic fractionalisation, social development and inequality, Africa is found to be short of social capital (Easterly & Levine, 1997 and Collier & Gunning, 1999). Possible reasons for this include ethno-linguistic fractionalisation and a lack of representativeness of government. Africa is highly fractionalised. Easterly and Levine (1997) measures fractionalisation by the probability that two randomly selected individuals in a country will belong to different ethno-linguistic groups. According to this, fourteen of the fifteen most ethnically heterogeneous societies in the world are in Africa. Such ethnic diversity increases polarisation. In turn, polarised preferences lead to a low provision of public goods, as it impedes agreement on the provision thereof. It also creates positive incentives for growth reducing policies, such as financial repression and overvalued exchange rates. 4

Easterly & Levine (1997) and Ghura (1995) mention the number of assassinations as a possible indicator. Bloom and Sachs (1998) uses five sub-indices to measure the quality of institutions. These include rule of law that reflects the degree to which the citizens of a country are willing to accept the established institutions to make laws and adjudicate disputes. There are a bureaucratic quality measures of the autonomy of the bureaucracy form political pressure and the strength and expertise to govern without drastic changes in policy or interruptions in government services. Measures of corruption in government reflect whether illegal payments are generally expected throughout government in the form of bribes connected to import and export licenses, exchange controls, tax assessments, police protection or loans.

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Ethnic diversity may also create rents for groups in power, at the expense of society at large (independent bribe-takers). The effects are even more significant in societies lacking political rights. This is of particular significance in Africa. In 1998 only 13 percent of the population lived in countries where legislators had been chosen in contended multi-party elections. This lack of representative government along with minority ownership of the modern part of the economy led to damaging economic control regimes and uncoordinated and competitive corruption (Collier & Gunning, 1999). A further explanation for the perceived low return on physical investment in African countries is because the public sector is used to create employment, and that reduces efficiency (Collier & Gunning, 1999). The resulting lack of complementarity between physical and human capital is often posited as a reason why physical capital is not flowing from the rich countries to capital-scarce countries in Africa. For instance Gries (1995a,b) analyses the role of human capital accumulation in the international allocation of goods and capital and finds that if human and real capital are complements, the domestic availability of human capital may determine the rate of domestic physical investments. The degree to which human capital can act as a complement to physical capital depends in part on the skills of the labour force (Gries, 1995a). A skill relates to the ability to use a certain technology. Technologies are embodied in capital goods: A certain capital good embodies a certain technology by the productive properties of the machinery. Hence the technology defines the link between human capital and real capital. This fixed link implies that a country with a certain human capital stock and structure will efficiently employ the adequate stock and structure of real capital. Accumulated local human capital determines the local requirements of real capital. A country is identified by the country's "characteristic endowment", namely the local abundance of human capital and labour. The endogenously determined human capital accumulation determines comparative advantages, the pattern of specialization and trade, and the direction of real capital flows. If the stock of accumulated human capital is small, little real capital is needed in domestic production. For a given world interest rate the required real capital is absorbed from internal and external sources. The domestic excess supply (demand) of real capital is provided to (taken from) the world markets. Thus, a region that accumulated little human capital will attract little real capital. The lack of domestic opportunities to invest will channel wealth accumulation to world markets. A capital outflow can be observed even for a poor region with little capital endowment, as is the case for Africa.

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1.3.2 The New Growth Theory The key factor in the "new growth theory" is human capital. But unlike in the extended versions of the traditional theory, human capital is not just accumulated. The new growth theory has identified human capital as an important factor that induces positive externalities, scale economies and innovations. On aggregate spillovers between firms and the multiple uses of techniques and skills in different fields give human capital almost the character of a public good. These positive externalities affect the production processes and generate increasing returns to scale at the aggregate level. With some special additional assumptions about the production of human capital or the creation of new technological knowledge, these models can generate endogenous growth processes. Technological progress is now endogenously generated. While a model of endogenous growth was first suggested by Uzawa (1965) the idea of human capital externalities was developed by Romer (1986, 1990a, 1990b), Lucas (1988) and extended and modified by Azariadis and Drazen (1990), King and Rebelo (1990), Rebelo (1991), Grossman and Helpman (1991b) and others. Several causes for increasing returns to scale have been introduced (Backus, Kehoe and Kehoe (1992)). For instance Arrow's learning by doing (Arrow (1962)) was used by Lucas (1988, ch.5) and Young (1991). The role of R&D or education as a source of endogenous growth, was suggested by Lucas (1988), Stockey (1991) or Romer (1987, 1990a,b), Grossman and Helpman (1991b), Aghion and Howitt (1992). Africa's geography, rural nature, and the nature of rural social capital can be identified in this vein as possible reasons for weak mechanisms for endogenising economic growth. For instance consider first the case of Africa's geography as explaining low levels of R&D, learning by doing and generation of increasing returns to scale. The climate, soils, topography and disease ecology of Africa negatively influences its agricultural productivity (Bloom & Sachs, 1998), transport costs and terms of trade (Naude, 2001). Africa, in particularly, sub-Saharan Africa has the highest proportions of land and population in the tropics. In all parts of the world, economic development in tropical zones lags far behind that in temperate zones. The underlying reason is a backlog in productivity growth. Differences in productivity growth and innovation between temperate and tropical zones reflect the interplay of a number of factors. First, many kinds of agricultural and construction technologies do not transfer well between ecological zones, making learning by doing difficult. Second, temperate zones have long had much higher rates of endogenous technological change than the tropics. Third, the tropics pose inherent difficulties in agriculture and public health. Fourth, the tropics are disadvantaged because they are far from large mid-latitude markets. Problems

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of transport costs are acute for African countries, both within the continent and between it and the rest of the world. It can be argued to prevent the establishment of production runs that can achieve economies of scale. As geography curtails productivity growth and the adoption of technology in Africa, growth is constrained (Naud, 2001). Considering the case of inadequate rural social capital to generate endogenous growth the first aspect that has been observed in African societies is that the traditional rural system is characterized by high costs due to forgoing specialization. The "forced" saving for consumption smoothing that this requires may force members to reduce capital accumulation. Government intervention, aimed to change the agricultural economy through the links between property rights and social learning and growth, has seen mixed results. Conferring marketable property rights to small farmers did not always succeed in overriding the traditional system and land transactions are limited (Tanzania, Mali, Niger, Nigeria and Ghana). In some instances traditional land rights did evolve toward marketability, but not enough to support investment. Investments remained unnecessarily illiquid and this reduces growth. Property rights also had a negative effect on inter-household resource allocation because hereditability created divergence in factor endowments and reduced growth. Specialization and trade in land were however insufficient to offset the negative effects. Social learning is the second mechanism whereby social capital was to affect growth through endogenising growth. In Africa, however, peer groups are small and segmented by gender. This provides little access to information that leads to innovation (Collier & Gunning, 1999). 1.3.3 Endogenous Growth and Openness to Trade There is a large "endogenous growth" literature dealing with the effects of international integration and international openness to growth processes (see Young (1991)). The reason for the importance of international integration and international openness is due to the fact that developing countries, such as those in Africa, can in most cases only enhance their technological knowledge by adoption of techniques developed outside of their country. The imitation of existing techniques instead of own innovation is the distinguishing feature between the growth processes of technological leaders and follower. Generally speaking countries at the middle or the lower end of the technological ladder face an advantage of backwardness (Abramowitz, 1979; 1986; 1992; 1993; Gomulka, 1991). The underlying idea is that technologically backward countries have a second mover advantage compared to innovating countries. This idea was first stated by Veblen (1915) and adopted by Gerschenkorn (1962). The advantage of backwardness is partly due to the fact that imitation is generally associated with lower risks, lower human capital requirements, and lower research expenditures than innovation activities. The

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potential to use existing and mature technologies for products in later phases of the product cycle offers the chance for a process of technological catch up due to imitation. This is especially true for countries at the middle or upper stage of the technological ladder. These countries may easily transform technological advantages into higher growth rates of productivity and therefore rapidly converge to the technological frontier of the leading economies. As the technology is taken from abroad there must be a channel to get hold of the international technologies. The idea that trade and economic integration tends to increase growth is supported by a number of empirical studies (see e.g. Michaely, 1977; Krueger, 1978; Balassa, 1978; World Bank, 1987; Helliwell, 1992; Edwards, 1992; and Dowrick, 1994). There are more ambiguous findings and the subjective classification of trade regimes as well as the sensitivity of coefficients may be criticized (Lai, 1993; Levine & Renelt, 1992). Nevertheless, the overall conclusion from the empirical literature tends to support the positive influence of open trade to growth. The empirical findings are supported by further theoretical considerations. Trade and imports as a diversified bundle of goods enable the country to get hold of modern technologies incorporated in imported goods. As a result a high degree of integration and high export shares are important preconditions for technological convergence. Another important argument why open economies usually face higher growth rates is that of higher competition in the markets of goods and services. Since competition is one of the predominating motivations for the adoption of advanced techniques, outward oriented economies are forced to use more modern and more efficient techniques than economies following a strategy of import substitution. A closely related argument is based on the consideration that trade is one of the dominating sources of technology transfer. Developing and newly industrializing countries are forced to import technology intensive intermediates and products. Although these products are mainly used for production purpose, they also offer a substantial chance to accumulate foreign knowledge by means of reverse engineering and imitation. Even in branches not able to compete with international suppliers positive spill over in terms of personnel and organizational knowledge frequently occurs. Therefore trade flows generate substantial external economies and thus strongly interact with the technological gap of a country. The reverse implication is that a lack of foreign exchange may heavily burden or even prevent the process of economic and technological upgrading. Nevertheless, a high degree of openness is not sufficient for technological upgrading. Backward economies must not only have access to modern technologies but also bring up resources necessary to efficiently absorb techniques available from abroad. Any technique is characterized by a variety of factors like the capital intensity, the scale of production, the mix of skilled and unskilled workers, and complementary services, just to mention a few. In gen-

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eral, technologies coming from industrialized countries will often not match the conditions of less developed countries. Therefore the degree of technological congruence and capability compared to the leading countries becomes a central issue for the process of technological upgrading (Abramowitz, 1992, 1993). As far as international integration is concerned, the first papers in this field investigated growth effects from integration for symmetric countries (Grossman & Helpman, 1991a; Rivera-Batiz and Romer, 1991a,b). In the symmetric case, integration will have positive growth effects. Integration increases total knowledge and due to rather special assumptions the growth rate in both countries will increase. In contrast, Rivera-Batiz and Xie (1992, 1993) found that in the asymmetric case integration may reduce growth rates. The latter result is not too surprising. In countries with human capital abundance, integration will intensify the production of manufactured human-capital intensive goods. This increasing production of manufactured products will shift skilled labor from the research sector to manufactured industry. The reduced human capital in the research sector decreases growth rates. Thus, following "new growth theory" the effects of globalization for growth of African countries that integrated with other countries cannot be unambiguously predicted. If openness may be beneficial for export growth, the literature seems fairly inclined to the view that higher export is good for growth. Michaely (1977) used Spearman rank correlation and found a positive relationship between exports and economic growth and that a minimum level of development is required for exports to benefit growth (see also Heller and Porter, 1978). Balassa (1978) found that exports have a positive effect on economic growth over and above the contributions of domestic and foreign capital and labour. Krueger (1981) found that export promotion strategies may not always generate export growth, but policies to encourage import substitution may retard export growth. Tyler (1981) stated that a positive and significant relationship exists between economic growth and manufacturing export growth. Kavoussi (1984) examined the effect of export growth on total factor productivity and found that a positive relationship is sensitive to the share of manufactured goods in total exports. Ram (1985,1987) found that exports are important for growth, also in low-income less developed countries. Moschos (1989) in fact suggested that a stronger positive relationship exists between exports and growth in low-income countries, compared to middle and higher-income countries. Concerning the direction of causality, Chow (1987) finds unidirectional causality where exports promote economic growth and structural transformation of the economy. Bhomani-Oskooee et al (1991) determined that there is a positive causality from export growth to economic growth for countries that are well known cases of successful export promotion strategies. Dodaro (1993) argues that in poor less developed countries the direction of causality will be from economic growth to export growth and in more advanced less de-

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veloped economies, from export growth to economic growth. In specific trade policy studies, Dollar (1992) determined that outward orientation accelerates the technological development of the economy and a significant positive relationship exists between growth and outward orientation. Edwards (1992) concluded that more open economies with less distortive trade policies tend to grow faster. Venables (1996) supported this and claimed that trade liberalisation triggers expansion of output equilibrium. From the above literature the reasons for the positive associated between openness, higher exports and higher economic growth may be due to the following. Firstly, from an allocational point of view, exports are argued to improve the allocation of resources in terms of comparative advantage (Ram, 1987). Allocational gains stem for the possibility of international specialisation (Tyler, 1981). Enlargement of the effective market size generates a number of technological benefits (Krueger, 1981). Indivisibilities in production are overcome, firms can use the minimum efficient plant size, utilise all capacity and exploit economies of scale (Balassa, 1978; Feder, 1982; Jung & Marshall, 1985 and Moschos, 1989). In addition, trade introduces international competition (Chow, 1987). There is competitive pressure to reduce X-inefficiency, (Jung & Marshall, 1982), and it necessitates technological improvements (Ram, 1985 and Moschos, 1989) and more efficient management (Feder, 1982). Thus, exports tend to increase total factor productivity (Balassa, 1978). These benefits also spill over to non-exported products that can then be produced more efficiently (Tyler, 1981). However, the marginal productivity between the export and non-export sectors differs and it is likely to be higher in the export sector (Feder, 1982). That is because the effect of export expansion on productivity growth is also sensitive to the share of manufactured goods in total exports. A shift to manufactured exports enhances the effects of exports on productivity (Kavoussi, 1984). In conclusion, exports can thus promote resource allocation to the more productive manufacturing sector, while having advanced comparative advantages that promote export and economic growth (Chow, 1987). Secondly, from the perspective of a two-gap model of development exports relax the foreign exchange constraint on growth (Ram, 1985). It is possible to use external capital for development without problems in servicing the debt (Dollar, 1992). That allows for increases of imports of productive intermediate inputs (Jung & Marshall, 1985) and promotes capital accumulation and growth (Dodaro, 1993). More open economies have the advantage of absorbing technological innovations generated in advanced nations (Edwards, 1992) and of the subsequent expansion in education and innovation (Eicher, 1999). The result is a higher level of income and a higher long-run rate of growth. Given the role of openness and growth discussed above, the arguments put forward can be used to evaluate the extent to which a possible lack of openness and success in exporting can be held responsible for Africa's economic

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divergence. The failure of African countries to penetrate export markets successfully, particularly in manufactured products, is clear from the fact that Africa's, and in particular sub-Saharan Africa's share of world trade fell dramatically over the past forty years. The region's share of world exports declined from 3.1 percent in 1955 to 1.2 percent in 1990. There was also major erosion of the region's ability to compete in international markets and Africa lost ground in key commodity exports (Ng & Yeats, 1998).5 There are a number of possible explanations for this lack of export success. The first is changes in Africa's ability to compete internationally. A general deterioration in Africa's competitive position is reflected in the 42 percent reduction in exports, below what would have occurred if only for demand changes (Ng & Yeats, 1996). Teal (1999) contributes the low level of competitiveness to Africa's low levels of skill and relative abundance of natural resources, which make exporting manufactures unprofitable. Furthermore, African governments created a high transaction costs environment that constrained export growth, while policy failed to promote the technological capabilities that are needed for successful industrialisation. Changes in demand conditions also provide an explanation for the poor trade performance. For Africa the demand factor was lower than for any other country group. In addition, Africa also became dependent on a relatively small number of commodities. Thus, it experienced declining market shares for its major export products, which were of declining relative importance in international trade (Ng & Yeats, 1996). Ng and Yeats (1998) identifies four factors that should also be taken into account to explain a county's trade and growth performance. The first is the level and structure of trade restrictions encountered in major export markets. For Africa, Teal (1999) found very little evidence that OECD trade protection caused the general loss of competitive position, reflected in Africa's declining market shares. The second is the domestic trade policy implemented by the country itself. Teal (1999) finds that African trade barriers are far more restrictive than that of any other region. The divergence in the case of non-tariff protection is even sharper. This has an adverse influence on exports and economic growth as tariffs on production inputs are high and place domestic producers at a substantial direct cost disadvantage compared to the fast growing exporters. Ng and Yeats (1998) proposes that government policies affecting the general business climate and the ability of local firms to exploit opportunities in foreign and domestic markets, as well as the physical characteristics of the country also influence trade and growth and should be taken into account. Inappropriate and often inconsistent macro-economic policies, lack of strong 5

Rodrik (1998) emphasises that one should keep in mind that there was a variety of performance within the region.

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political and social institutions, social capital and financial depth, as well as adverse geography in Africa have already been discussed.

1.4 THE CATCHING-UP PROCESS The reasons for Africa's divergence have been outlined using the standard and new economic growth theories in section 3. This section attempts to provide an understanding of the catching-up process itself, in order to identify the economic growth strategies that African countries should follow in order to at least prevent further diverging from the global economy. It is argued in this section that multinational enterprises (MNEs), through their function of integrating global production structures through foreign direct investment (FDI) may have a key role to play in the catching-up process. The link between the importance of MNEs and catching-up growth is provided by one of the most innovative contributions in the new growth literature, namely the modeling of innovations on a firm level. With the endogenous "production" of technological progress diverging growth processes in different countries can be explained. The internal accumulation and allocation of resources - especially of human capital - determines the R&D activities, the technological ability and finally the productivity growth rates of a country. Therefore, growth opportunities are determined endogenously and the countries preferences determine the growth position. It is therefore the mechanics of new growth theory that suggests why growth processes may differ and divergence can be observed. The probably most important factor responsible for the technological capability is the stock of real and human capital available to the economy. The predominating role of human capital endowments can be explained by several theoretical ideas. Many of the points made by the "new growth theory" concerning the role of human capital for innovations will hold for imitations as well. Sufficient human capital is a precondition for a successful adoption and use of advanced technologies in a country. This proposition is supported by a number of empirical studies (see e. g. Fagerberg, 1994). The conclusion that can be drawn form the empirical literature is that the countries that tended to catch up are those with a high initial level of human capital and high investment rates (Baumol et al., 1989; Barro, 1991). Verspagen (1991) also finds that countries with low social capabilities (proxied by education) run the risk to be caught in a low growth trap. In addition, the complementarity of human capital to technology in the processes of research and production is commonly suggested in the literature (see OECD (1996) for a discussion). In section 3 it was shown that African countries started out with insufficient levels of human capital, and closed economies that prevented the inflow of investment and foreign technology.

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If a country meets sufficiently favorable conditions - integration and sufficient human capital - a process of technological upgrading begins. Because the country can rely on technological knowledge already available from outside, it will be able to realize higher productivity growth rates than countries at the technological frontier. As a result the countries technological gap will diminish. Africa's divergence in this view is thus to a large extent due to a growing technological gap between it and the rest of the world. If one sees catching up to require as a minimum that the technological gap be closed, then the process of catching up can be roughly divided into four different phases. These phases can be exemplified by the economic development of the eastern Asian countries. At the beginning the process of upgrading will be relatively slow due to the missing technological congruence as well as the low endowment with human capital compared to the leading economies. But in a second phase, if the country is able to assimilate higher incomes into the additional accumulation of physical and human resources, the process of upgrading may become self sustained or even accelerate. After a period of rapid convergence the third phase starts. This phase is characterized by a slowdown of technological progress and growth. The slowdown is due to counteracting forces rooted in the process of upgrading. Although the country is now able to adopt more and more advanced techniques the set of technologies available for imitation will continuously diminish as the technological gap becomes closed. Therefore resources necessary for imitation will increase relative to gains in productivity. The last phase is characterized by a process of convergence and essentially determines the final technological position relative to the leading countries. Countries that do not bring up the internal and external conditions for upgrading are unable to use their comparative advantages as technological followers. Therefore, these countries will stagnate or even diverge (Gries & Wigger, 1993). Foreign Direct Investment (FDI) is an important channel - and possibly at the current stage the only channel for African countries - to adopt advanced technologies. But in reality only a few countries are obviously able to support their process of upgrading by means of foreign real and human capital investments. The reason is that technologically backward countries are not only characterized by higher returns on investment compared to industrialized countries but also by a high default risk due to unstable technological and social environments. The premium necessary to compensate this risk will tend to counterbalance the return differential or - in the worst case - exceed it. This might explain why most FDI take place within the industrialized elite. In addition to the industrialized elite only a few countries are actually able to substantially attract international capital flows, especially the Eastern Asian economies forming club 3. This observation suggests that capital flows - FDI - importantly interact with the technological gap of a country.

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FDI will generally tend to speed up the process of technological upgrading because it raise the rate of capital accumulation and offer additional access to advanced techniques. Therefore upgrading economies have a good chance to attract additional capital through FDI that in turn tend to speed up the process of catching up. In the debate on the strategies open to African countries to speed up economic growth, the role and nature of MNEs and FDI is relatively understated (see eg Collier and Gunning, 1999). It is important to note that the importance of MNEs in economic globalisation is due to their functions in providing Foreign Direct Investment (FDI) and of leading to growing intra-firm trade (Welfens, et al., 1999:3). Although African countries remain amongst the most "closed" economies in the world6, many have begun to implement trade liberalisation programmes and adopted outward-orientation as a growth strategy (see e.g. Gelb, 1999a;1999b). FDI and the benefits of intra-firm trade, given that international technology transfer is primarily in the form of intra-firm deals, may thus hold significant growth-benefits to Africa as a whole. Rising FDI and involvement of MNEs could stimulate economic growth in Africa to the extent that it facilitates micro-economic, structural changes required for the African economic environment to become more "investment friendly". It is the type of benefits that FDI and MNEs could impart that could be beneficial in this regard to Africa within a global economy, namely technology spillovers, international technology trade, improved use of know-how and a higher overall investment-output ratio (Welfens, et al., 1999:v). A possible policy/co-ordination problem that may exist is that the above requirement may imply that Africa is locked into a low-growth equilibrium, whereby FDI/MNEs are required to create the conditions favourable for investment in a global economy, but that FDIs/MNEs do not perceive Africa as a desirable investment destination at present, despite promising macroeconomic reforms and growing trade liberalisation. For instance, despite the fact that returns on FDI in Africa was almost 60% higher than that in other developing regions during the period 1990-94, it attracted less than 2% of all flows to developing countries by 1995 (roughly US $2bn. Per annum, exc. South Africa) (see Jaspersen, et al., 1998; Bhattacharya, et al., 1996).

1.5 CONCLUSION This chapter provided the basic research question to which a partial answer will be sought in the chapters that will follow. This question also motivates the recently announced New partnership for African Development (NEPAD)7 6

See Sachs and Warner's (1995) broad definition of closedness and openness in an economic context. 7 See www.nepad.com

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proposed by South Africa, Nigeria and Algeria. The question is, can African countries attain sufficiently high economic growth rates to catch up in per capita income terms with other developing countries? In a context of increasing globalisation, this chapter found that Africa requires investment by multinational enterprises (MNEs) to improve its competitiveness and to facilitate micro-level structural changes required to reduce its riskiness as an investment environment. In the debate on the strategies open to African countries to speed up economic growth, the role and nature of MNEs and FDI is relatively understated. It is important to note that the importance of MNEs in economic globalisation is due to their functions in providing Foreign Direct Investment (FDI) and of leading to growing intrafirm trade. Although African countries remain amongst the most "closed" economies in the world8, many have begun to implement trade liberalisation programmes and adopted outward-orientation as a growth. FDI and the benefits of intra-firm trade, given that international technology transfer is primarily in the form of intra-firm deals, may thus hold significant growthbenefits to Africa as a whole. Rising FDI and involvement of MNEs could stimulate economic growth in Africa to the extent that it facilitates microeconomic, structural changes required for the African economic environment to become more "investment friendly". It is the type of benefits that FDI and MNEs could impart that could be beneficial in this regard to Africa within a global economy, namely technology spillovers, international technology trade, improved use of know-how and a higher overall investment-output ratio. Hence, Africa might be in low-growth equilibrium trap, unless factors and conditions can be identified such that MNEs can become more involved in African economies.

8

See Sachs and Warner's (1995) broad definition of closedness and openness in an economic context.

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CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs T. GRIES* University of Paderborn, Germany Thomas.GriesQnotes.uni-paderborn.de

2.1 INTRODUCTION As discussed in the previous chapter, the global growth process is rather heterogenous. There may be certain clubs of countries with similar growth experiences like catching-up clubs or groups that are falling behind. Many African countries experienced a process of relative divergence towards the leading individualized country group. Some Sub-Saharan countries suffered from even decreasing per capita income. This chronic failure of economic growth during the last two decades was not typical for Africa. As Collier/Gunning (1999) point out, in the 60s, Africa's growth prospects were encouraging. By 1950 Africa had overtaken Asia and between 1960-73 a booming economy was going along with decolonialization. Today, 32 countries are poorer now than in 1980. Today, Africa is the world's region with the lowest income. Looking at these facts many contributions in the literature try to identify the obstacles for a dynamic growth in Africa. What caused the decline in growth rates? Internal and external factors as well as policy made problems and exogenous destinies are suggested. Sachs/Warner (1997) and Gallup/Sachs (1999) emphasized adverse external destiny factors for African people like the fact of being atypically landlocked or an adverse climate. Others like Collier/Gunning (1999) stress more on poor or even counterproductive domestic policy activities. And Ndulu/O'Connell (1999) or Deaton (1999) try to identify some interactions between external factors and negative domestic policy outcomes. In this book we will not be able to conclude in this discussion. Our interest is more limited. We just focus on the role of FDIs for the development process in (South) Africa. Therefore, before turning to the more micro and firm oriented chapters it seems favorable to introduce a short theoretical model which may give an idea of the major development mechanisms and the effects of the domestic factors as well as FDIs on the catching-up process.

*The theoretical model of this chapter traces back to Gries (2002)

38

T. GRIES

The theoretical model of this chapter will focus on three problems: (i) We must introduce a model with a stylized development mechanism, which captures the empirical observed regimes of catching-up as well as fallingbehind. That is, the model should allow to identify the conditions for a switch from stagnation to dynamic upgrading. (ii) The model should clearly distinguish between the contributions of domestic factors and external factors on growth and development. (iii) The model should be able to identify the effects of FDIs on the development process and draw a general picture of the potential role of FDIs for development. In our model the developing economy will be modeled as a small open economy in the economic neighborhood of industrialized countries. The human resources of the economy are defined as the major domestic factor of production. For simplicity this human factor will be called human capital. Even if as Schultz (1999) pointed out - the literature on aggregate evidence of human capital returns to growth has a number of shortcomings, there is little doubt, that "...the available evidence does tend to show that higher initial levels of education tend to be associated with more rapid subsequent growth." Schultz (1999 p.72.) Further, in our model human capital stands for a broad concept of human abilities as discussed by Schultz (1999). Human Capital is the central domestic economic factor. There are two sectors, a final good sector and R&D sector. As the country is backward the R&D sector is describing the imitating process. In other words, the process is not a research and developing process as it is known in an industrialized country. Imitation includes all learning and spill over effects that are leading to increasing productivity on aggregate. The presence of foreign firms, and their communication and exchange with the domestic economy is the channel of foreign know how and new ideas in the domestic imitation process. Therefore, foreign direct investments, human capital and technological spill over effects are important factors for the production of the final good as well as for the imitation of technologies. Successful catching-up requires the closing of the technological gap towards the leading countries of the industrialized world. Like the new growth theory this paper emphasizes the importance of technological diffusion and the accumulation of human capital as the main sources of income growth. Technological diffusion through direct investments and the ability to use technologies in production determine growth opportunities.

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39

2.2 THE MODEL The representative African economy is a small open economy integrated into world markets. The economy is characterized by a technological gap towards the industrialized world in the phase of economic catching-up. The economy consists of two sectors, a production sector and a research and development sector. The inputs of production are real capital and human capital denoted K and H respectively. FDIs are regarded as the only source of real capital accumulation. The production function for the final product is described by the Cobb-Douglas X = Ka{THx)l~a.

(2.1)

where X denotes the output and Hx the amount of human capital used for the production of goods. T is the technological efficiency depending on the state of technological knowledge available in the economy. Since the economy is technologically backward, it does not create new knowledge, but acquires new technologies by adopting foreign designs. The process of adopting foreign technologies consists of three elements: •

Foreign direct investments enable the country to get hold of so far unknown production and organization methods. FDIs indicate international links and can channel knowledge into the backward country. Therefore, technological advance is positively related to the flow of FDIs. FDIs are generally used to increase technological abilities.

•

Technologies embodied in FDIs have to be unveiled. FDIs can improve and speed up technological progress, but technological progress still needs other domestic resources. The process of adoption will use human capital.

•

The ability to increase the domestic stock of technological knowledge is positively related to the technological gap between the backward country and the industrialized world2. If the domestic stock of knowledge is low, it is relatively easy to increase knowledge by adopting foreign knowledge. But this process becomes increasingly difficult as the technological gap diminishes.

2 This in fact is the well-known Veblen-Gerschenkron-Hypothesis which states that at the outset of a catching-up process simple technologies will be copies, which can be easily imitated while later on more sophisticated technologies have to be unveiled. For a formal model including trade and structural change see Gries/Jungblut (1997).

40

T. GRIES

Thus, we assume that the country's internal rate of technological progress T can be described as

f = K0{eHT)1-0.

(2.2)

where K denotes the growth rate of the stock of real capital as a result of FDIs, HT = H — Hx is the amount of human capital used in the R&D-sector and is an index of technological backwardness. The index of backwardness is defined as 1 — w with w = T/V and V as the state of technological progress in the industrialized world. The resources devoted to the research sector are regarded as a constant fraction 7 of GDP: PTT

= 7K

(2.3)

PT is the price of adopted technologies and T = ^ . Y denotes GDP and is defined as

Y = PTf + X. Thus, the value of copied technologies can be derived as

T^X-

(2 4)

-

Since we want to focus on FDIs, we do not assume domestic capital accumulation. The flow of foreign direct investments / = K is determined according to the arbitrage condition r = Srw,

(2.5)

where r denotes the rate of return of FDIs, rw the world's interest rate and 5 > 1 a risk premium factor. Later we will discuss how a change of ± caused by political crisis will affect growth opportunities of a country. The marginal return of FDIs is given as

4 Thus we receive K = X. Further, using equation (1) to derive the growth rate of output we get X = aK + (1 — a)T and therefore K =f

(2.7)

The efficient allocation of human capital requires identical marginal products in both sectors | ^ = 9^T which is equivalent to

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs

41

(2-8)

Using equation (9.4) to substitute for the right hand side of this equation we can solve for H,=c,H

with

d :=

( 1

_^y^\_7)

(2.9a)

F r = c2F

with

c2 :=

(1_ffl^g;)(1_7)

(2.9b)

and

Thus the allocation of human capital is constant over time. Equations (7) and (9b) can be used to substitute for K and HT in equation (2). The resulting equation can be solved for T as t = c29HT.

(2.10)

While domestic knowledge is endogenous, the technological progress of the industrialized world is assumed to grow with a constant exogenous rate n: V = nV.

(2.11)

Therefore, the time path of the relative technological position, w = y , is given by T v W = f - yW

Using Equations (10) and (11) yields w =(&- n)w - $"w2

(2.12)

with $ := c2H It is possible to solve the logistic differential equation (12) explicitly. The solution can be derived as (2.13) and WQ = w(0) as the initial value of the relative technological position. This solution suggests the possibility of two different dynamic regimes for the time path of technological upgrading depending on \P.

42

T. GRIES

W(t)'

final } technology gap

100%

Fig. 2.1. Technological Convergence and Divergence Path (a) For 0/ < n the ratio of technological knowledge w(t) will converge to zero, i.e the country cannot close the technological gap and will diverge (see figure 2.1, case (a)). (b) For #• > n the ratio of technological knowledge w(t) will increase and the country will follow a s-shaped process of technological upgrading. But, even in the long run a final gap 1 — — will remain and the country cannot fully close the technological gap without switching from imitation to innovation (see figure 2.1, case (b)).

2.3 RESULTS What are the most important determinants for the path of development and the final position of the economy? (i)The role of the domestic factor, human capital: For given values of a, f3 and 7 the condition ^f > n can be expressed in terms of the minimal human capital requirements necessary for successful upgrading: H>

(1-/3)7

(2.14)

Therefore, the process of technological upgrading will only be successful, if the country meets the human capital requirements given in condition (14). The critical endowment of H must be higher, the higher the rate of international technologies progress n. The value of \P = &(H) is not only important at the beginning of the upgrading process, but also determines the final technological position

2 CATCHING-UP, FALLING-BEHIND AND THE ROLE OF FDIs limt^oo w(t) = 1 - £

43 (2.15)

Since the GDP path has the same property as the path of technological upgrading, the economy will only catch-up in terms of GDP, if human capital is abundant (see (iii)). The higher the endowment with human capital, the smaller the final technological gap. The final technological gap remains as long as the economy does not change from imitation to innovation. This switch is not covered by the model. Here we describe imitation and adoption of foreign designs. Innovation processes are quite different to imitation processes. Modeling innovations would be much more complex. In addition we also would have to take more care of describing human capital as being creative rather than technical, (ii) The role of FDIs for technology upgrading: Equations (14) and (15) show that the flow of foreign direct investments does neither influence the critical level for technological convergence nor the final technological position of the economy given in figure (2.1). The link between FDIs and technological capabilities is given by K = T. Thus, foreign direct investments can only accelerate technological growth as long as the economy converges, i.e. T > n. Although FDIs are important for the process of catching-up the switching condition for upgrading as well as the final level of the technological position is solely determined by the stock of domestic resources. The human capital endowment of the economy is eventually the critical factor. This theoretical finding goes along with empirical findings by Bin Xu (2000). In this study for US multinational enterprises Bin Xu found out: "the level of human capital is crucial for a country to benefit from technology spill over of MNEs. These results are also consistent with the findings of single country studies that the technology spill over effects of MNEs are positive in advanced countries and insignificant in less developed countries" [Bin Xu (2000) p. 491]. The analysis therefore points out that the role of FDIs may be generally overestimated, especially with respect to the question if a country is able to take a path of convergence. On the other hand, FDIs are often not just the inflow of foreign capital and the embodied technology. Some times the host country is not able to provide sufficient technical and managerial knowledge to operate the sophisticated foreign capital. Therefore, in many cases multinational firms send a bundle of factors containing real and complementary human capital. If this additional human capital would significantly contribute to the total stock of domestic human capital, the critical endowment could be reached. In this case FDIs and complementary inflowing human capital would push the economy on a convergence path. (iii) The role of FDIs for the GDP growth path: In our model FDIs are important with respect to the GDP path. Equation (2.13) determines the

44

T. GRIES path of technological upgrading of the economy (see Figure 2.1). Using (2.1), (2.4), (2.5) and (2.6) the path of GDP can be derived as

Since the leading industrialized countries grow at the constant rate n, their GDP can be expressed as Yw(t) = c^Vit) where c3 is constant. Thus, the relative GDP level of the modeled economy is given by y(t) = ^=cd^w(t)

with c:= T ^( g ^)T^fiiJ

As a result the path of the relative GDP of the country has the same properties as the path of technological upgrading. Therefore, the economy will fall behind in terms of GDP, if the economy is technologically falling behind (& < n). In this first case the relative GDP of the economy will finally converge to zero. This case might be relevant for African economies during the last two decades. As long as African economies are unable to provide sufficient domestic human capital a dynamic take of process is not likely to start. A critical level of human capital defines the turning condition for successful development. The second case (& > n) was relevant for the East Asian economies during the last two decades and may also draw a perspective for future development of African Economies: Economies in the process of technological upgrading will catch-up toward the leading industrialized countries (see Figure 2.1, case (b), solid line). The path of the relative GDP will be s-shaped. But, even in the long run these economies will not be able to fully close the GDP gap as long as the technological gap remains. Analyzing the s-shaped path of convergence two phases have to be distinguished. During the first phase growth is much higher than the growth rates of the leading industrialized countries. In the second phase of catching-up the forces of deceleration lead to decreasing growth rates, as the advantage of backwardness of the upgrading economy diminishes. Thus, the speed of technological upgrading reduces. (iv) Growth effect of the destabilizing politics and political risks: Due to political crisis investing in these economies becomes more risky. The increasing uncertainty leads to a rising risk premium in the model. A high risk premium 82 > di (a low level of FDI) reduces the steady-state path of GDP of the economy (see Figure 2.2). If the economy is able to technological upgrade ((\P > n)), the economy will switch to a lower GDP path at time £0 a n d finally approach a lower steady-state. Thus, due to a higher risk premium the GDP gap increases. The steady-state path of GDP will reduce and the economy will finally reach a lower GDP position.

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100%

Fig. 2.2. Growth Effects of Increasing Risk and Uncertainty

2.4 CONCLUSION By introducing a simple formal model we tried to give an idea of a stylized development process of an African economy with special attention to the role of FDIs. As the country is underdeveloped the R&D sector is describing the imitating process. Foreign direct investments, human capital and technological spill over effects are important factors for the production of the final good as well as for the imitation of technologies. It is shown that the economy will face a divergence regime as long as the domestic factor, human capital endowment, is below a critical level. Although FDIs are important for the process of catching-up the switching condition for upgrading as well as the final level of the technological position is solely determined by the stock of domestic resources. Without a sufficient domestic factor, no take off to a dynamic catching-up process takes place. Therefore the results emphasize the importance of the domestic factor. The role of FDIs may be generally overestimated, especially with respect to the question of convergence or divergence. Having reached this critical level of human capital, the process of upgrading towards the industrialized world is not linear, but s-shaped. Successful catching-up requires the closing of the technological gap towards the leading countries of the industrialized world. FDIs are important for the level and speed of GDP growth. Therefore, political risks and increasing uncertainty will lead to a decreasing level of FDIs and will reduce the path as well as the steady-state income level of the economy.

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REFERENCES Barro, R. J. (1990). Government Spending in a Simple Model of Endogenous Growth, Journal of Political Economy, Vol. 98, 5, part II, 103-125. Barro, R. J., LEE, J. W.(1993). International Comparisons of Educational Attainment, Journal of Monetary Economics. 32, 363 - 94. Barro, R.J., Sala-i-Martin, X. (1995). Economic Growth, New York: McGrawHill. Bin Xu (2000). Multinational Enterprises, Technology Diffusion, and Host Country Productivity Growth, Journal of Development Economics, Vol. 62, 477 - 493. Collier, P., Gunning, J. W. (1999). Why Has Africa Grown Slowly?, Journal of Economics Perspectives, Vol. 13, Number - Summer 1999, 3-22 Collier, P., Gunning, J. W. (1999). Explaining African Economic Performance: Journal of Economic Literature, March, 37(1), 64-111. Deaton, A. (1999). Commodity Prices and Growth in Africa, Journal of Economic Perspectives - Vol. 13, Number 3, 23 - 40. Gallup, J. L., Sachs, J. D. (1999). Geography and Economic Growth, in: Proceedings of the Annual World Bank Conference on Development Economics. Pleskovic, Boris and Joseph E. Stiglitz, eds. World Bank, Washington, DC. Gries, T. (2002). Catching-Up, Falling Behind and The Role of FDI: A Model of Endogenous Growth and Development, The South African Journal of Economics, Vol. 70(4). Gries, T., Jungblut, S. (1997). Catching-Up and Structural Change, Economia Inter-nazionale, Vol. L, 4, 561-582. Gries, T., Wigger, B., Hentschel, C. (1994). Endogenous Growth and R &D Models: A Critical Appraisal of Recent Developments, Jahrbucher fur Nationalokonomie und Statistik, Vol. 213, 1, 64-84. Grossman, G. M., Helpman, E. (1991). Innovation and Growth in the Global Economy,Cambridge MA: MIT Press. Lucas, R. E., Jr. (1988). On the Mechanics of Development Planning, Journal of Monetary Economics, Vol. 22, 1, 3-42.

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Ndulu, B. J., O'Connell, S., A. (1999). Governance and Growth in SubSaharan Africa, Journal of Economics Perspectives - Vol. 13, Number 3 Summer 1999, 41- 66. Romer, P. M. (1986). Increasing Returns an Long-Run Growth, Journal of Political Economy, Vol. 94, 5, 1002-1037. Romer, P. M. (1990). Endogenous Technological Change, Journal of Political Economy, Vol. 98, 5, part II, 71-102. Sachs, J. D., Warner, M. (1997). Sources of Slow Growth in African Economies, Journal of African Economies, 6, 335-76. Schulz, T. P. (1999). Health and Schooling Investments in Africa, Journal of Economic Perspectives - Vol. 13, Number 3- Summer 1999, 67 - 88.

THE DETERMINANTS OF FOREIGN DIRECT INVESTMENT IN AFRICA W. KRUGELL* North-West University, South Africa

3.1 INTRODUCTION Africa faces significant challenges in low growth, persistent poverty and high inequality. The Economist of 24th February 2001 refers to an "elusive dawn" in Africa, as African leaders' Millennium African Renaissance Programme confronts war, disease, corruption and half of sub-Saharan Africa's 600 million people living in absolute poverty. It may be argued that foreign direct investment (FDI) presents a possible solution to the growth and development challenges in Africa. FDI supplies capital and provides for spillovers of foreign technology and know-how to host economies. This may aid growth and development. Currently many African governments are reshaping their policy frameworks in an effort to attract FDI. Yet there has been little empirical work done on the determinants of FDI in Africa. This chapter provides a theoretical and empirical analysis of the determinants of FDI in sub-Saharan Africa. Theories of the internationalisation of production are used to outline the reasons why multinational enterprises (MNEs) undertake FDI. These reasons help to identify the conditions and policies that might draw FDI to Africa. The empirical analysis tests for the significance of a number of hypothesised determinants of FDI, in sub-Saharan Africa. The pooled cross-country and time series estimation covers the period 1980 to 1999 for 17 countries. The results show the importance of economic growth, domestic investment and macroeconomic stability, for attracting FDI.

* Lecturer in the School of Economics, Risk Management and International Trade, at the North-West University, Potchefstroom, South Africa. The chapter is based on work undertaken for the MSc dissertation at the University of Warwick in 2001. The author would like to thank Kim Scharf and Wim Naude for their helpful comments. The usual disclaimer applies.

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Section 2 introduces the challenges facing African countries and presents FDI as a possible solution. The case is made for the significance of identifying the determinants of FDI in Africa. In section 3 the theory and evidence of the determinants of FDI are examined. Dunning's (1993) OLI-theory serves as the basis for current thinking on the determinants of FDI. The overview of recent empirical findings shows the importance of economic variables such as market size and wage costs as determinants of FDI. The empirical analysis for sub-Saharan African countries is presented in section 4. Section 5 provides some conclusions and recommendations.

3.2 THE POTENTIAL ROLE OF FDI IN AFRICA The so-called African development "tragedy" defines the continent's lack of growth, and limited development. Over the last four decades Africa has been the only region where per capita income fell, while the average global per capita income doubled (ADR, 2000). In Africa an estimated 350 million people live on $1 per day or less. Ranked by Human Development Index, eighteen of the world's twenty lowest ranked countries are in Africa (World Bank, 1999). Although the African economic scene of the late 1990s offers some hope of recovery in a number of countries, the challenge remains that of accelerating broad-based economic growth for development. FDI has been put forward as a possible solution to this challenge. FDI is an amalgamation of capital, technology, marketing and management2 (Cheng & Kwan, 2000). Over the past twenty years international production and FDI has grown rapidly. At the end of 1999 the global stock of FDI stood at $5 trillion. The ratio of world FDI inflows to global capital formation was 14 per cent in 1999 - compared with 2 per cent twenty years ago. The role of foreign capital in developing countries has grown in accordance with the global trends. In 1999 developing countries received $208 billion in FDI. That constituted an increase of 16 per cent over 1998 and an all-time high (WIR, 2000). These FDI flows are argued to benefit growth and development. In host countries, labour is combined with domestic and foreign owned physical capital in the production process. FDI affects growth directly by increasing the stock of physical capital - new inputs supplement those in the production process. Investment drives capital accumulation, which drives growth. FDI affects growth indirectly through effects concomitant with greater openness: technology spillovers and knowledge transfers (De Mello, 1999). Technology spillovers from TNCs promote technological upgrading in the host 2

For measurement purposes FDI refers to net inflows of investment to acquire a lasting management interest (ten per cent or more of voting stock) in an enterprise operating in an economy other than that of the investor (Hawkins & Lockwood, 2001).

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country. This leads to process innovations whereby old goods are produced using newer technologies. FDI induces human capital development through knowledge transfers. The existing stock of knowledge in the recipient economy is augmented through labour training and skill acquisition and diffusion. Knowledge transfers may also take the form of alternative management and organisational arrangements. Technology and human capital also have productivity spillover effects by which FDI leads to increasing returns to domestic production (Stoker, 2000). This promotes growth in the long run. In practice, however, the distribution of international production and the benefits associated with it, is unequal. Developed countries receive nearly three-quarters of the world's FDI flows. Only 10 developing countries receive approximately 80 per cent of total FDI flows to the developing world. Net private capital flows to Africa are only a small portion of the total. Africa's share of FDI flows is small and has been declining (Chaudhuri & Srivastava, 1999). In 1985 Africa received a 3.1 per cent share of worldwide FDI flows. This declined to 2.3 per cent in 1997 and 1.2 per cent in 1998. Inflows rose from $8 billion in 1998 to $10 billion in 1999, but that was not enough to increase the African share and it remained at 1.2 per cent (WIR, 2000). These limited flows should not be taken to indicate that Africa has little investment potential, or that FDI can make only a limited contribution to growth and development. There are a number of arguments to the contrary. •

Although Africa's share of FDI flows has fallen in comparison with other regions, the flows have been positive (UNCTAD, 1998). The aggregate data belies the fact that a number of African countries are doing well. Recently, low-income countries like Uganda and Tanzania have been able to sustain gradual increases in FDI inflows (WIR, 2000).

•

The FDI that does take place is becoming more diversified. Diversification is being aided by the opportunities created by privatisation programmes (WIR, 2000). It is not the absolute size, but the relative size of the inflows that should be examined. Many African economies are small and when inflows are measured per capita, or per $1000 of GDP, several countries are faring considerably better than the average for African countries and some even better than the average for developing countries. Examples include Guinea, Seychelles, Angola and Botswana (UNCTAD, 1998).

•

The potential for attracting FDI exists, as FDI in Africa is profitable. A study of United States affiliates in Africa over the period 1980 to 1993 shows that the rate of return on FDI in Africa was considerably and consistently higher than the average for developed and developing countries (UNCTAD, 1998).

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In policy circles, the arguments in favour of a role for FDI in African growth and development are not only being made, they are also being acted upon by African governments. Recently many African countries have taken steps to attract FDI by improving their policy frameworks. Efforts include reforms aimed at increasing the role of the private sector in the economy, for example through privatisation. There are also steps taken to ensure and maintain macroeconomic stability, such as devaluation of overvalued currencies and the reduction of inflation rates and budget deficits. African countries are improving their regulatory frameworks for FDI - some 26 of the 32 least developed countries in Africa, surveyed by UNCTAD in 1997, have a liberal or relatively liberal regime for the repatriation of dividends and capital (UNCTAD, 1998). Progress is also being made with trade liberalisation, as well as the strengthening of the rule of law, and improvements in legal and other institutions that matter for the FDI climate. Finally, many African countries are establishing investment promotion agencies and have concluded bilateral investment and double taxation treaties that contribute to the creation of a more secure environment for foreign investors on the continent (UNCTAD, 1995). Though, as the statistics have shown, there has only been limited success in attracting FDI. Thus, it is clear that if African governments are to successfully formulate policies to attract FDI, it will require a clear understanding of why MNEs undertake FDI, and of the host country characteristics that draw FDI in. As yet, little work has been done on the determinants of FDI in Africa. Recent examples of the studies that do exist include the following. UNCTAD (1995) examines the principal economic determinants of FDI flows to Africa for the period 1991 to 1993. This study takes into account the level of development, market size, market growth and natural resource endowments as determinants of FDI. The conclusion is that in many African countries the full potential for FDI remains unexploited. The report does not however explain this further. McMillan (1995) provides a discussion of the determinants of FDI flows to Ghana and Cote d'lvoire, but no empirical analysis. Loods (2000) gives a broader overview of the trends and determinants of FDI flows to Africa, but also no empirical analysis. Chaudhuri and Srivastava (1999) offers an empirical investigation of the lack of private capital flows, which includes FDI, to sub-Saharan Africa, using a panel of thirty countries over the period 1986 to 1993. They find that total long-term private capital flows as a ratio of GDP is explained by factors determining the investment climate: that the impact of high and unsustainable budget deficits, low creditworthiness and high country risk on the investment climate in Africa has resulted in the dearth of private capital flows to the region. It is clear that a specific treatment of the determinants of FDI in Africa is required.

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3.3 THEORIES OF FDI There is no single theory of the internationalisation of production. One can however argue convincingly that MNEs undertake FDI in order to maximise profits. They spread their activities over different locations to enhance their competitiveness by capturing new markets and by acquiring new resources and skills. The determinants of FDI should thus be examined from the viewpoint of how they confer efficiency or cost advantages on the firms that undertake FDI. Dunning's (1993) theory of ownership, location and internalisation (OLI) advantages states that there are three conditions for a firm to become transnational and undertake FDI. The first is that the firm should possess net ownership advantages (intangible assets) that firms of other nationalities in the particular market do not have. This could be proprietary right to a product or a production process that the MNEs can exploit in foreign markets. Whatever its form, the ownership advantage confers market power or a cost advantage on the firm, that is sufficient to outweigh the disadvantages of doing business abroad. The second condition is that it must be of greater benefit to the firm possess these ownership advantages, to utilise them internally, than it is to rather sell or lease them to foreign firms. Thus the benefits of in-house transactions should exceed those of external markets. Finally, it must be profitable for the firm to employ those advantages with factor inputs outside its home country. These inputs can be natural resources in a host country or, for example, labour at low cost. A factor such as access to customers may also be important. Fulfilment of these three conditions may be seen as an explanation of the internationalisation of production and of why firms undertake FDI. It is important to note that the ownership and internalisation advantages are firm specific advantages whereby FDI yields efficiency gains or cost savings. The location advantages are country specific. Thus, in order to determine why FDI flows to some countries instead of others, the host country characteristics that allow foreign firms already possessing ownership advantages to maximise profits there, need to be examined. For this purpose, Wang and Swain (1997) classifies host country characteristics into micro-, macro- and strategic determinants of FDI. 3.3.1 Micro-determinants of FDI The micro-determinants of FDI are mainly concerned with those locationspecific factors that have an impact on the profitability of FDI at firm or industry level. Host country characteristics that influence productivity and cost at this micro-level include market size and growth, labour costs, host government policies and tariffs and trade barriers.

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3.3.2 Market Size and Growth FDI is likely to be attracted to host countries with large local markets and higher levels of economic development. A large, growing domestic economy ensures the TNC of a market for its product and provides for scale economies (Lucas, 1993). Transaction costs are also likely to be lower (McMillan, 1995). Evidence from empirical studies provides strong support for the importance of market size as a determinant of FDI. Wang and Swain (1997) surveys a number of early studies from the 1960s and 1970s and concludes that most studies come out in support of the size or growth of the markets in the host countries, as a significant determinant of FDI. In more recent work, Schneider and Frey (1985) and Wheeler and Mody (1992) also find market size to be related to FDI flows. 3.3.3 Labour Costs Labour costs are a clear consideration in a MNEs decision to employ its ownership advantages outside its home country. As wages rise, FDI aimed at low cost, efficient production, tends to be discouraged. Though, as wages rise relative to the cost of capital, there may be a tendency to substitute foreign capital in the place of labour (Lucas, 1993). Firms may also not only be interested in the lowest wages. MNEs may seek skilled labourers and professionals (Veugelers, 1991). Rather than just low wages, it is important that wages reflect productivity (Wang & Swain, 1997). MNEs aim to maximise profits through efficiency gains and/or cost minimisation. A related factor to take into account is that of labour disputes. A given host country is less attractive the greater is the incidence or severity of industrial disputes (Yang et al., 2000). The results of time series and cross-country analyses are also strongly in favour of relative low wages as a significant determinant of FDI flows. Specifically in the case of developing countries, Wheeler and Mody (1992) and Lucas (1993) finds a positive and significant relationship between lower labour costs and FDI inflows. Urata and Kawai (2000) ties this in with the nature of the MNE. They find that relative low wages are an important determinant of FDI by Japanese small and medium-sized enterprises (SMEs). The Japanese SMEs produce in neighbouring Asian countries in order to reduce their factor costs. Production is then exported back to Japan. In contrast, larger firms are more concerned with local sales and the size and growth of the host market.

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3.3.4 Host Government Policies Host government policies are location specific factors that may influence profitability and MNE's decision to undertake FDI, in a number of ways. Such policies include incentives and performance requirements (UN, 1995). Host governments often offer incentives to increase the attractiveness of their location. The incentives aim to encourage FDI inflows by reducing costs and making investment more profitable. Specific measures include tax breaks and trade incentives, like duty-free imports of inputs. The incentive schemes are often closely linked to efforts by the host government to encourage investment in export industries, or preferred sectors, or in less developed areas of the country. Most host countries believe that incentive schemes are crucial for attracting FDI, because competing economies have similar schemes. Related to incentives are performance requirements. A host government can place performance requirements on investors to try to ensure that the benefits of FDI accrue to the country. This takes the form of requirements concerning the hiring and training of local personnel, local content, technology transfer and exporting of output. Where incentive schemes may attract FDI, the interference of government performance requirements may deter it. To negate this possible negative effect governments often link meeting the requirements to fiscal incentives like tax rebates. The empirical literature, however, finds the impact of government policies to be less straightforward. Helleiner (1989) finds that specific incentives do not have a major impact on FDI flows. Incentives influence the decisions of investors only at the margin. Dees (1998) adds to this, citing a survey according to which investment incentives are only moderately significant for the decision of US firms to invest in China. The evidence does show that removing restrictions and providing good business operating conditions will affect FDI flows positively. 3.3.5 Tariff and Trade Barriers The so-called "tariff hopping" hypothesis states that high protective trade barriers make exports by MNEs to a potential host country, uncompetitive. Potential marketing cost savings, from avoiding protectionist barriers, as well as transport cost reductions, encourage MNEs to rather enter the market through FDI and to serve their customers with local facilities (Wang & Swain, 1997). A growing internal market will add to the attractiveness of tariff hopping. Jun and Singh (1996) tests the tariff hopping hypothesis and finds the relationship between taxes on international trade and transactions, and FDI, to

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be positive and significant. Yung et al. (2000) supports this result but with a different method. Measuring the openness of the Australian economy as the sum of exports and imports as percentage of GDP, they find a negative relationship with FDI. They subsequently argue that FDI inflows substitute for trade, much like the case made in the tariff-hopping hypothesis. It should be noted that the influence of these location-specific microdeterminants of FDI depends on a number of factors. Firstly, the nature of the investment is important. If the investment is for export production, the expected return from a particular site will depend more heavily upon unit input costs. If the investment is intended to serve the local market, then the size and openness of the market will be of significance. The stage of the product's life cycle, as between a new, mature or standardised commodity may also be of significance. Locations with lower input costs are important when the product is standardised. One or a combination of these factors may tip the balance and encourage a firm to locate production facilities in a particular country.

3.4 MACRO-DETERMINANTS OF FDI The macro-determinants of FDI are the factors that influence profitability and the choice to invest at an economy-wide level. These are the size and growth of the host market and factor prices. Factor prices are in turn influenced by tariffs and taxes. Thus there is much of an overlap with the micro-determinants of FDI, though the emphasis here is on the influence that the general macroeconomic environment has on FDIflows.The effects of the macro-environment are also reflected in a number of additional determinants of FDI. These include openness and export orientation, exchange rates, the inflation rate, budget deficit, domestic investment as well as political risk. 3.4.1 Openness and Exports There are number of arguments linking openness, and exports, and FDI flows. The tariff-hopping hypothesis described in the previous section posits that there is a negative relationship between openness and FDI. Closed economies receive FDI, which is substituting trade. The opposing view is that outwardorientated economies are more successful at attracting FDI. The pressure of international competition makes for higher productivity. An outward-orientated economy is also not handicapped by the size of its domestic economy when attracting FDI - it offers efficiency and access to world markets. Empirical studies of whether a host country's export orientation may be important for attracting FDIflowsfindin favour of openness. Lucas (1993) finds that in Southeast Asian countries FDI is more elastic with respect to the demand for exports, than with respect to the aggregate domestic demand. Jun

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and Singh (1996) states that exports should be included as a control variable because of the higher export propensity of foreign affiliates. They find a particularly strong relationship between exports in general, and manufacturing exports in particular, and FDI. One should however note that the empirical literature raises a causation question - whether FDI flows are attracted to economies that are export orientated or whether FDI leads to increases in exports. Jun and Singh (1996) argues that the relationship is likely to be simultaneous, with current results supporting the general notion that exports precede FDI. 3.4.2 Exchange Rates Related to openness is the importance of exchange rates as a determinant of FDI flows to host economies. There are broadly two lines of thought concerned with the significance of exchange rates as a determinant of FDI: the currency area hypothesis and considerations of exchange rate risk. The currency area hypothesis argues that firms from harder currency areas are able to borrow at lower costs, and to capitalise the earnings on their FDI in softer currency areas at higher rates, than the local firms. The higher the share of capital value added and the size of the premium on the local currency, the greater the comparative advantage which foreign investors enjoy over local firms and that attracts FDI. The second line of argumentation takes account of the exchange rate risk to which MNEs are exposed when undertaking FDI and how that influences the decision to locate in a particular country. The nature of the risk firstly depends on the MNEs' activities in the host country. If the MNEs produce for export, depreciation is beneficial, making output more competitively priced. However, if a substantial portion of inputs is imported, depreciation raises costs. Even when the nature of TNC activity is not taken into account, the exchange rate may be important. Large fluctuations in the rate discourage FDI flows, as it increases uncertainty associated with the economic environment of the host country (Urata & Kawai, 2000). The exchange rate also determines the value of repatriated profits. In developing countries a deteriorating exchange rate and foreign exchange position may further threaten restrictions on such remittances, irrespective of what exchange controls are normally in place (Lucas, 1993). Empirical evidence on the significance of the exchange rate as a determinant of FDI is indeterminate. Studies of the effect of exchange rate devaluation on FDI shows that it depends on whether MNEs in a country are dependent on the foreign market relatively more for the export of their outputs, or for the import of their inputs (Wang & Swain, 1997).

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3.4.3 Inflation Rates Where the exchange rate reflects external economic balance or imbalance, the inflation rate is an indicator of a country's internal macroeconomic stability. Increased instability adds to uncertainty and makes investment unattractive. A high rate of inflation is a sign of internal economic tension and the inability or unwillingness of the government and the central bank to balance the budget and to restrict money supply (Schneider & Prey, 1985). This increases uncertainty regarding the business environment. Inflation also increases the cost of production (Urata & Kawai, 2000). Consequently it has a negative impact on FDI flows. Empirically this is confirmed by Schneider and Prey (1985), Yung et al. (2000) as well as Urata and Kawai (2000). 3.4.4 Budget Deficits The budget deficit is similarly related to uncertainty and the choice to invest. A high or increasing budget deficit is not a host country characteristic that encourages FDIflows.It is more likely to cause uncertainty regarding the sustainability of the host government's fiscal stance and about what that may imply for the cost and profitability of investment. Empirical work by Chaudhuri and Srivastava (1999) supports a negative and significant relationship between budget deficits and FDI flows. 3.4.5 Investment and Infrastructure FDI supplements domestic capital but it may be argued that the causation also runs the other way: domestic investment crowds in FDI. It does so by increasing productive capacity (Chaudhuri & Srivastava, 1999). In the same way infrastructure creates an enabling environment for foreign investors. It increases productivity and reduces the cost of production, which draws in FDI. Empirical results from Wheeler and Mody (1992), Cheng and Kwan (2000) as well as Urata and Kawai (2000) confirm this relationship. 3.4.6 Political Instability Political instability embodies a variety of concerns, ranging from production disruption to confiscation or damage to property, to threats to personnel, to a change in macroeconomic management or the regulatory environment (Lucas, 1993). Political instability is expected to decrease FDI because it increases uncertainty about the cost and profitability of investment. McMillan (1995) notes that stability may not however have the opposite positive effects. It adds to a general feeling of investment security, but does not have the specific "pull" as strong as that created by market forces.

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Empirical studies produce mixed results. Wang and Swain (1997) finds that evidence from surveys of MNEs and their executives support a negative correlation between FDI flows and political instability. Evidence from cross-section studies, on the other hand, shows that political variables are of minimum concern to investors and are generally given the same treatment in FDI decisions as in domestic investment decisions. Wheeler and Mody (1992) uses a broad component measure of administrative efficiency and political risk. This includes measures of the likelihood and nature of a government change, the attitude of opposition groups to FDI, the likely degree of labour disruptions, the local terrorism risk factor, the difficulty in obtaining approvals and permits from bureaucrats, bribes required, as well as the efficiency and integrity of the legal system. They find the aggregated measure to be statistically insignificant. As an alternative to the composite indicator approach to measuring socio-political risk, Lucas (1993) uses episodic dummies for "good events" and "negative events" in East and Southeast Asian countries. "Good events", such as the Asian and Olympic games in the Republic of Korea, or President Aquino's accession in the Philippines, are found to be positively related to FDI. "Negative events", such as Park's assassination in the Republic of Korea, or Ferdinand Marcos' martial law in the Philippines, are found to be negatively related to FDI. Jun and Singh (1996) attributes the conflict between the results of the various studies to the difficulty in obtaining reliable quantitative estimates of a qualitative phenomenon, for an extended period of time. Wang and Swain (1997) add that the definition of political instability is particularly problematic. Econometric studies of the determinants of FDI may focus on events characterising political instability when they should be concerned with the potential manifestation of those events as constraints upon foreign investors. Political instability does not always enhance political risk to FDI.

3.5 STRATEGIC DETERMINANTS OF FDI The strategic determinants of FDI refer to long-term factors influencing the decision to invest in a country. MNE strategy determines FDI when it is undertaken to defend existing foreign markets, or to diversify a firm's activities. The strategy may also be to gain/maintain a foothold in a protected market, to gain/maintain a source of supply through FDI, or to gain advantage in complementing another type of investment. When considering the strategic determinants of FDI, there is less that a host country can do to attract FDI - this is more about the characteristics of the MNE. Although this discussion has shed some light on the host country characteristics that draw in FDI, it is clear that the literature on the determinants of FDI is wide ranging. Alongside there exists a wealth of empirical studies ex-

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amining the significance of these determinants. The tentative conclusion may be that larger, open, more stable economies are more likely to attract FDI flows. There is however little proof of the significance of these determinants of FDI in Africa. Section 4 estimates a model of the determinants of FDI for 17 countries in sub-Saharan Africa.

3.6 EMPIRICAL ANALYSIS Empirical studies of the determinants of FDI can be based on three approaches: micro-orientated econometric studies, survey data analyses and aggregate econometric analyses. The analysis here uses an aggregate econometric approach at the country level, discerning only some of the macroeconomic determinants of FDI. 3.6.1 The FDI Econometric Model Following Jun and Singh (1996), a simple stock-adjustment model is used to describe the determinants of FDI. The single equation model: FDI? = A + B(CVt) + Et

(3.1)

states that the desired FDI stock at time t{FDlf) is determined by a vector of control variables (CVj), discussed below, and a random error term Et. The speed of adjustment is incorporated into the model as shown in the following equation: FDIt - FDIt-i = Z(FDI? - FDh-i).

(3.2)

Equation (3.2) shows that changes in actual FDI will respond only partially to the difference between the desired FDI and the past values of that investment. In any given period, a desired level of FDI may not be realised fully (as actual FDI in the subsequent period), because of physical and procedural constraints. The parameter Z captures the speed of adjustment to the desired level of FDI. By substituting FDlf from equation (3.1) into equation (3.2) and rearranging, equation (3.3) is obtained: FDIt = ZA + BZ(CVt) + (1 - Z)FDIt-i + ZEt

(3.3)

Thus, FDIflowsat time t is a function of a vector of control variables, FDI flows in the previous period and a random error term. Each of the explanatory variables takes the speed of adjustment to the desired level of FDI into account. In addition to the rationale given in a simple stock adjustment model,

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using the lagged dependent variable as an explanatory variable also takes care of any residual autocorrelation that might exist. It incorporates indirectly other omitted factors that may have influenced FDI in the previous period (Jun & Singh, 1996). Using the previous empirical studies, reviewed in chapter 2, as a guide to the variables to include, the fully specified model is defined as follows: RFDI = A + Bi{RFDIl) + B2{GDPCAP) + B- 3(GDPGROW)+ B4 {GDI) + B5 (OPEN) + B6 (INF) + B7 (OVR) + (3.4) B8(SECSCHOOL) + B9(PHONE) + Et

The dependent variable (RFDI) is FDI inflows in constant dollars as a ratio of GDP. Several control variables are included in the model: past FDI flows, market size and growth and domestic investment. There are also measures of the openness of the economy, internal and external stability, the quality of labour, as well as infrastructure. The specification of the variables and hypotheses of the coefficients are as follows. •

Past FDI flows

FDIflowsare likely to require time to adjust to their desired levels, depending on the specific constraints facing MNEs. Including past FDI flows (RFDI1) serves to show the partial adjustment process incorporating the speed of adjustment of actual levels, to desired levels of FDI flows (Jun & Singh, 1996). It may also serve as a crude measure of agglomeration effects. Agglomeration effects exist when the localisation of industry generates positive externalities - and past FDI attracts more FDI (Cheng & Kwan, 2000). •

Market size and growth

FDI has been argued to be attracted to host countries with large local markets. Previous empirical evidence has shown market size to be one of the most important determinants of FDI. For equation (3.4), the size of the market (GDPCAP) is measured by real GDP per capita in constant dollars (international prices, base year 1985). The data is obtained from the Penn World Tables 5.6. The higher GDP per capita, the better are the prospects that FDI will be profitable. Also, market growth is an indicator of a good development potential in the future. The growth of the market (GDPGROW) is measured by GDP per capita growth (annual percentage) and again a positive influence on FDI is expected. Jun and Singh (1995) notes that when the dependent variable is FDI relative to GDP, the relationship of FDI with other GDP related variables on the right hand side of equation (3.4) may not be unequivocal. Hence, both per capita GDP and the growth rate of per capita GDP are included to control for actual and potential market size.

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•

Domestic investment

Domestic investment improves a country's productive capacity and may crowd-in FDI. The GDI-variable represents gross domestic investment as a percentage of GDP, as measured in the World Development Indicators. A positive relationship with FDI is expected. •

Openness

The survey of the theoretical and empirical literature in section 3 has shown that there are divergent views on the relationship between the openness of the economy and FDI flows. Tests of the significance of openness as a determinant of FDI in African countries encounter data problems. Statistics of taxes on international trade and transactions are incomplete or not available for the countries in the study. This precludes a direct test of the "tariff hopping" hypothesis. To evaluate the arguments in favour of an outward orientation, this study includes the OP.E'./V-variable, which represents total trade as a percentage of GDP. Total trade is imports plus exports. This is similar to the measure used by Yang et al. (2000) and the aim is to capture the total effects of the host country's exposure to the outside world. The data is from the World Development Indicators. The effect of openness on FDI is uncertain. •

Inflation

Inflation is used as a measure of internal economic stability. A high rate of inflation reflects macroeconomic instability, which adds to uncertainty and makes investment unattractive. Inflation (INF) in this study is inflation of consumer prices (annual percentage), with the data coming from the World Development Indicators. A negative relationship with FDI is expected. •

Overvaluation

The real overvaluation of the domestic currency is used as a measure of external economic stability. Overvaluation of a currency indicates that macroeconomic policies may be unsustainable, which increases uncertainty (Agarwal, 1980). The OVR-variable represents a real effective exchange rate index from Dollar (1992) and the World Development Indicators. A negative relationship with FDI is expected. •

Quality of labour

Skilled labour is hypothesised to be more productive and to attract FDI. Secondary school enrolment (percentage gross) is used as a rough measure of the quality of labour (SECSCHOOL). The data is again from the World Development Indicators.

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Data availability precludes further analysis of hypotheses concerning labour. This is unfortunate considering the importance of low-cost labour as a determinant of FDI flows in studies of other regions. Data on industrial disputes and strikes in African countries are also only available for the last few years and have many gaps. •

Infrastructure

Infrastructure provides an enabling environment for the foreign investor and increases a country's productive capacity. This is proxied by the PHONEvariable, which is the number of telephone mainlines per thousand people. A positive relationship with FDI is expected. The model is estimated using panel data estimation techniques. The analysis covers the period 1980-1999 for 17 countries in sub-Saharan Africa. The choice of countries is based on the availability of consistent data. The 17 countries in the basic specification are: Benin, Burkina Faso, Burundi, Central African Republic, Democratic Republic of the Congo, Gambia, Lesotho, Malawi, Mauritius, Niger, Nigeria, Rwanda, Senegal, Seychelles, South Africa, Uganda, and Zimbabwe. For the estimation of a pooled cross-country and time series model, the interpretation of the relationship between FDI and the explanatory variables, as they are modelled in equation (3.4), needs to be extended. In panel data, two different types of models can describe the relationship, namely the fixed effects model and the random effects model (Chaudhuri & Srivastava, 1999). In the fixed effects model, RFDIjt gives the value of FDI flows (RFDI) for a specific country (the jth unit) in a particular period (time t). RFDIjt depends on M exogenous (control) variables, as they are set out in equation (3.4). The values of the exogenous variables differ among countries in the cross section at a given point in time and also exhibit variation through time. RFDIjt also depends on variables that are specific to a particular country and that stay constant over time. The model can be expressed as: RFDIjt = OLJ + P\CVjt) + et

(3.5)

where j = the 17 countries mentioned above and t = 1980, . . . ,1999. Here (3 is an M x 1 vector. The at is a scalar constant representing the impact of variables that are specific to a country and remain constant over time. The random error term et shows the effects of these omitted variables that are specific to both countries and time periods. This is also known as the Leastsquares dummy variable model. The estimator is ordinary least squares.

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The random effects model is specified in a similar fashion, but country specific effects (the a, s ) are treated as random variables. The model can be written as:

RFDIjt = f3\CVjt) + Ht

(3.6)

The fijt now presents a combined error term consisting of a.j and Sjt. The errors are assumed to have a zero mean, to be uncorrelated and homoscedastic. The model is also known as the variance components model and it is estimated with the generalised least squares estimator. The choice between fixed and random effects can be a difficult one. In this case the random effects model is estimated, following the motivations of Wheeler and Mody (1992). Since the aim is to examine the relationship between FDI flows and host country characteristics, much of the interesting variation in the data is across countries, reflecting conditions that change only slowly (for example market size). The use of country specific dummies (fixed effects) would have the result of removing this variation, leaving only short-run, withincountry changes as the basis for parameter estimation. The results would tell much less about the host country characteristics that attract FDI. The fully specified model, that is estimated as a random effects model, can be restated as follows:

RFDIjt = aj + ^(RFDIljt) + f32(GDPCAPjt)+ fo(GDPGROWjt) + fa{GDIjt)+ (35(OPENjt) + lh(INFjt) + (37{OVRjt)+ fo{SEC'SCHOOL jt) + /39{PHONEjt) + et

3.7 RESULTS AND INTERPRETATION A number of different specifications of the model are estimated. In the very basic specification past FDI flows, GDP per capita, GDP growth and gross domestic investment explain FDI. The other variables are added progressively to the model. Note that all the variables are ran with a one-period lag. The results of four of the estimated models are reported in Table 3.1. Model 1 is the basic model relating FDI flows to past FDI flows, GDP per capita, GDP per capita growth, domestic investment and openness. The results show the expected signs on all the coefficients with the exception of that of GDPCAP. GDP per capita is found to be negatively related to FDI flows with a small and insignificant coefficient. Past FDI flows and gross domestic investment are found to be positively and significantly related to current FDI flows at the 5 per cent level.

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3 DETERMINANTS OF FDI IN AFRICA

In model 2 the effect of inflation is added. The /./VF-coefncient has the expected negative sign, but the coefficient is small and statistically insignificant. Adding the variable for inflation also causes GDI to no longer be statistically significant and it reverses the sign on GDPGROW. GDP per capita growth is now found to be negatively related to FDIflows,though the coefficient is small and insignificant. The coefficient on past FDIflowsis still positive and significant. Openness is positively and significantly related to FDIflowsat the 10 per cent level.

Dependent Variable

Model 1

Model 2

Model 3

Model 4

RFDI

RFDI

RFDI

RFDI

Constant

0. 154 (4. 221)*

0. 142 (2. 238)

0.074 (2. 775)

0. 145 (7. 003)

RFDI 1

0.376 (7. 050)*

0.472 (5. 870)*

0.784 (18. 986)*

GDPCAP

-0. 0002 (-0. 373)

-0. 0003 (-0. 478)

GDPGROW

0.010 (0. 522)

-0. 004 (-0. 131)

-0. 0003 (-1. 269) 0.035 (1. 949)*

-0. 108 (-1. 138) 0.007 (5. 685)*

GDI

0.094 (2. 608)* 0.005 (0. 330)*

0.064 (1.032)

0.093 (1. 899)*

0.050 (1.946)**

0.023 (1. 649)** -0. 015 (-1.427)**

OPEN

-0. 007 (-0. 544)

INF

0.008 (0. 460) 0.007 (0. 199) 0.061 (5.611)* -0. 023 (-2. 979)*

0.014 (1. 189)

OVR

0.295 (0.371)

PHO Adjusted R2

0.46

0.81

0.84

0.53

F

39.5

114.4

101.5

18.9

D.W.

2.424

2. 172

2.906

1.752

238

168

143

108

Number of Observations Note: t - statistics are given in ]larenthesis * denotes at 5 % level ** denotes at 10% level

Table 3.1. Empirical Results

In model 3 overvaluation of the domestic currency also enters as an explanatory variable. It has an unexpected positive sign and is statistically insignif-

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icant. This however seems to be the best specified model. It explains 84 per cent of the variation in FDI flows and finds most of the determinants to be significant, with the expected signs. Past FDI flows are a positive and significant determinant of current FDI flows. GDP per capita growth is again positively and significantly related to FDI. Investment and openness are found to be positive and significant and inflation negative and significant at the 10 per cent level. Model 4 adds the infrastructure variable. This makes for some contradictory results. Note that this model is estimated for a much smaller number of countries (only 9) and has to exclude the overvaluation variable since the estimation procedure requires that there be more cross-sections (greater number of countries) than there are variables to be estimated. The number of phone lines per 1000 people has the expected positive relationship with FDI flows, but the coefficient is statistically insignificant. The inclusion of PHO however causes past FDI flows to be negatively, though insignificantly, related to current FDI flows. Both GDP per capita and GDP per capita growth now have the expected positive relations to FDI. Though the coefficient is small, GDPCAP is now even statistically significant. The openness and inflation variables have their expected signs and are statistically significant at the 5 % level. In addition to the models reported on, a number of less successful specifications were also attempted. The SEC SCHOOL measure of the quality of labour was used in a regression of FDI flows on past flows, market size and growth, and investment. This was again for a smaller number of countries. The results show SECSCHOOL to have a negative and insignificant relationship to FDI. It was also attempted to use the lengths of roads, instead of the number of phone lines, as a measure of infrastructure. The data, however, shows very little variation and thus has limited explanatory power. Finally, it was attempted to include a measure of political risk. This was unsuccessful due to data problems. The first constraint is that there is no time series data available for the period. The typical measures of political risk are only assessed intermittently. The alternative is to then use indices from the international country risk guide to define dummy variables indicating bureaucratic quality, corruption and the risk of expropriation. This is a crude measure at best and it suffers from the additional problem that it is not available for a number of the countries in the sample. When added to the models above, the regression can be done only for four countries, which leaves little room for adding the explanatory variables. In the end these less successful attempts were abandoned. Thus, the results confirm some of the conventional wisdom of the determinants of FDI and provide for a few surprises. Firstly, past FDI seem to be the most important determinant of current FDI flows to the countries. The coefficient is large, positive and highly significant in most specifications of the

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model. Without industry level data it may be presumptuous to infer that these are agglomeration effects. It may be more likely that when FDI is already taking place in a country, MNEs see that as a signal that it is a save and suitable country to invest in and more FDI follows (Urata & Kawai, 2000). Secondly, Africa's small and under-developed economies do not attract FDI on the basis of their market size. In the main specifications GDP per capita is negatively related to FDI. The growth of the market may remedy this, as the models largely found a positive relationship between GDP per capita growth and FDI. The results further show that foreign investors prefer an environment conducive to their activities. That is an environment with low inflation and thus less uncertainty. Domestic investment attracts FDI by increasing the productive capacity of the economy. There is some evidence in favour of greater outward orientation as a determinant of FDI. To some extent, however, this maybe drawn into question by the unexpected positive relationship found between overvaluation of the exchange rate and FDI flows. Though the coefficient is small and insignificant it is a cause of concern. A possible explanation may be that the overvaluation of the exchange rate reflects the more restrictive trade regime found in African countries. Overvaluation may be positively related to FDI to the extent that the FDI is "hopping" the barriers that cause the overvaluation. This, unfortunately, contradicts the results on the OPEN-variable. It may also be taken to indicate that FDI in these African countries are more market-seeking than efficiency-seeking. That is again difficult to reconcile with the negative relationship found between market size and FDI flows. It is clear that further investigation is needed.

3.8 CONCLUSIONS Conclusions and recommendations should be made with care. The analysis may be faulted on its very nature. Firstly, the nature of the determinants is such that they do not change much over short periods of time. Hence change in such variables is not likely to be very successful in explaining changes in FDI over time (UN, 1995). Secondly, the analysis pools data for a group of countries that may be structurally diverse. Structural differences refer to significant discrepancies in the basic macroeconomic variables that characterise an economy. Aggregate analysis may conceal as much as it reveals (Jun & Singh, 1996). Thus, it is problematic to apply a broad brush of recommendations.

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The recommendation that can be made is that African countries should focus their efforts on staying the course of what is today regarded as prudent governance. A stable macroeconomic environment may be important for attracting FDI flows and it is important for growth and development prospects in general. In the same way, domestic investment enhances a country's productive capacity and it may crowd-in FDI flows by creating an enabling environment for the activities of foreign investors. Although the results on the importance of the openness of the economy for attracting FDI were mixed, the state of the art currently favours open, outward-orientated economies for growth. Future African growth and development prospects will not be enhanced in closed economies. Although this chapter has been able to analyse some of the economic determinants of FDI in Africa, a number of questions are unanswered and allow for recommendations for further analysis. Firstly, extensions of the study should attempt to address some of the data problems mentioned in section 4. Indicators of wage costs and political risk would be valuable. A possible extension indicated by the growth accounting literature for Africa, would be to examine geography and natural resources as determinants of FDI. However, finding data on transport costs or resource exports may again be problematic. Finally, it can be said that it should be kept in mind that the determinants of FDI depend on many factors - not least of these the nature of FDI itself. As African countries shape their policies to attract FDI, they should also consider the type of FDI they wish to attract. The discussion in section 3 showed that some MNEs are market seeking and others are efficiency seeking and export orientated (Cheng & Kwan, 2000, Resmini, 2000). Thus there are different determinants of the different types of FDI to take into account.

REFERENCES ADR, see AFRICAN DEVELOPMENT REPORT. African Development Report, (2000). Regional integration in Africa. New York: Oxford University Press. Agarwal, J. P. (1980). Determinants of foreign direct investment: A survey, Weltwirtschaftliches Archiv, 116, pp. 739-773. Anon. (2001). Africa's elusive dawn. The Economist, Feb. 24. Chaudhuri, K., Srivastava, D. K. (1999). Dearth of private capital flows in sub-Saharan Africa, Applied Economics Letters, 6, pp. 365-368.

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Cheng, L. K., Kwan, Y. K. (2000). What are the determinants of the location of foreign direct investment? The Chinese experience, Journal of International Economics, 51, pp. 379-400. Dees, S. (1998). Foreign direct investment in China: Determinants and effects. Economics of Planning, 31, pp. 175-194. De Mello, L. R. (1999). Foreign direct investment-led growth: Evidence from time series and panel data. Oxford Economic Papers, 51, pp. 133-151. Dollar, D. (1992). Outward-orientated developing countries really do grow more rapidly: Evidence from 95 LDCs, 1976-1985, Economic Development and Cultural Change, 40, pp. 523-544. Dunning, J. H. (1993). Multinational enterprises and the global economy. Workingham: Addison-Wesley. Easterly, W., Sewadeh, M. (2001). Global development network growth database. [Available on the internet:] http://www.worldbank.org/research/growth/GDNdata.htm. Hawkins, P., Lockwood, K. (2001). A strategy for attracting foreign direct investment. (Paper delivered on 13 September 2001 at the conference of the Economic Society of South Africa.) Glenburn Lodge, Johannesburg. (Unpublished). Helleiner, G. K. (1989). Transnational corporations and direct foreign investment. (In: Chenery, H. and Sriniv, T.N. eds. Handbook of Development Economics. Vol. 2. Oxford: North-Holland, pp. 1441-1480.) Jun, K. W., Singh, H. (1996). The determinants of foreign direct investment in developing countries. Transnational Corporations, 5. pp.67-105. Loods, E. (2000). Foreign direct investment flows to African countries: Trends, determinants and future prospects. Mots Pluriels, 13. [Available on the internet:] http://www.arts.uwa.au/MotsPluriels/MP13000el.htm. Lucas, R. E. (1993). On the determinants of foreign direct investment: Evidence from east and south-east Asia. World Development, 21, pp.391-406. McMillan, S. (1995). Foreign direct investment in Ghana and Cote d'lvoire. (In: Chan, S. ed., Foreign direct investment in a changing global political economy. New York: St. Martin's Press, p.150-165.)

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Resmini, L. (2000). The determinants of foreign direct investment in the CEECs: New evidence from sectoral patterns. Economics of Transition, 8, pp.665-689. Schneider, F., FREY, B.S. (1985). Economic and political determinants of foreign direct investment. World Development, 13, pp.161-175. Stoker, H. (2000). Growth effects of foreign direct investment - myth of reality? (In: Chen, J. ed. Foreign direct investment. Houndsmills: MacMillan, pp.115-137.) UNCTAD see United Nations Conference on Trade and Development. (UN) United Nations. (1995). Sectoral flows of foreign direct investment in Asia and the Pacific. ESCAP studies in trade and development. No. 5. New York: United nations, p.17-25. United Nations Conference on Trade and Development. (1995). Foreign direct investment in Africa. Division on transnational corporations and investment. Current studies, Series A, No. 28, New York: United Nations. United Nations Conference on Trade and Development. (1998). Foreign direct investment in Africa: Performance and potential. New York: United Nations. Urata, S., Kawai, H. (2000). The determinants of the location of foreign direct investment by Japanese small and medium-sized enterprises. Small Business Economics, 15, pp.79-103. Veugelers, R. (1991). Locational determinants and the ranking of host countries: An empirical assessment. Kyklos, 44, pp.363-382. Wang, Z. Q., Swain, N. (1997). Determinants of inflow of foreign direct investment in Hungary and China: Time-series approach. Journal of International Development, 9, pp. 695-726. Wheeler, D., Mody, A. (1992). International investment location decisions: The case of US firms. Journal of International Economics, 33, pp. 57-76. WIR see World Investment Report. World Bank. (1999). World development indicators. Washington D.C.: World Bank. World Investment Report. (2000). Cross-border mergers and acquisitions and development. New York: United Nations.

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Yang, J. Y. Y., Groenewold, N., Tcha, M. (2000). The determinants of foreign direct investment in Australia. Economic Record, 76, pp. 45-54.

THE GLOBAL INTEGRATION OF AFRICA: The EU-SA Free Trade Agreement and German MNEs in South Africa W. NAUDE, 1 W. KRUGELL 2 and N. BAUER 3 1 2 3

North-West University, South Africa North-West University, South Africa University of Paderborn, Germany

4.1 INTRODUCTION4 According to the United Nation's Human Development Index (HDI), 18 of the 20 least developed countries in the world are in Africa. Africa's unsatisfactory economic development experience has in recent years come increasingly under scrutiny. The so-called African development "tragedy" is reflected in persistent poverty, low growth and high inequality. During the 1980s, the average growth in GDP per capita in Sub-Saharan Africa (SSA) was -1.3%. Current estimates put per capita income in Africa (in P P P terms) at roughly US$ 1045 - more than 10 times lower than that in the average OECD country. The result of low growth and low per capita incomes is that more than 40% of the African population may be living below the accepted poverty line of US$ 1 per day. Taking into account measurement methods, Africa also has the most unequal distribution of income in the world - exceeding that of Latin America. On a political level, calls have increasingly been made for Africa to reverse this process of economic underdevelopment through "African unity". Calls for and discussions about an "African Century", "The African Renaissance", a "United States of Africa" has all been prominent in recent times. Of course, calls for African unity is nothing new - the Abuja Treaty of 1948 having already called for an African Economic Union by the year 2000. This chapter critically assesses, from an economic point of view, the potential of regional economic integration amongst African countries for promoting 4

An earlier version of this paper was presented at a Graduate Seminar, Faculty of Economic Sciences, Universitat-Gesamthochschule Paderborn, January 2000. The authors wish to thank the many participants, in particular Professor Mike Gilroy, for their useful comments.

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economic development in Africa. It does so by considering the recent explanations for Africa's poor economic development and by assessing the African experience with regional integration. The insights from these analyses are then combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. The chapter concludes, with reference to the recent Free Trade Agreement between South Africa and the EU, that integration amongst African states may be sub-optimal to integration between African states and a higher income region (e.g. the EU) and that regional cooperation in terms of economic policy and political stability may be vital in the face of significant neighbourhood effects on economic growth. Seen in this way, the contribution of this chapter is to call on African states to focus on economic integration with countries outside of Africa for expansion of trade and for obtaining technology and investment. In this, the paper sounds a positive note on the advantages of globalisation for African economic development. African countries should furthermore not expect of economic integration agreements amongst themselves to lead necessarily to greater trade. The advantage of regional integration amongst African countries lies rather in its potential to enhance economic policy co-ordination and the adoption of sound macro-economic policies and governance practices. The economic development case for regional integration between Euroland and Southern Africa can thus be made. The chapter is structured as follows. In section two it is showed that there is a great consensus that a major cause of Africa's disappointing economic performance is that fact that African economies are amongst the most closed economies in the world to international trade. It is argued that regional integration is called for as a way to ensure trade liberalisation but on a limited scale. In section three Africa's experience with regional integration in the past is seen not had been successful, and that it had contributed little to intraregional trade in Africa. In fact the argument that regional integration can assist to enlarge the markets for African products is shown to be false, as most African countries have similar revealed comparative advantages and trade in the same basic commodities. In section four some new contributions to the theory of regional integration are set out. These contributions can be applied to the African situation to argue that regional integration may present Africa with a lose-lose situation and that integration between African economies and a higher-income economy may be preferential. Section five concludes.

4.2 AFRICA'S ECONOMIC CRISIS The economic crisis in Africa has led scientist and policy makers to use a number of approaches to gather evidence as to the causes of the crisis. These ap-

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proaches included us of cross-country growth regressions, case studies as well as micro-economic survey evidence on households, markets, firms, labourers and investors. Micro-economic longitudinal surveys have been conducted with increasing regularity in African countries since the early 1990s. These include household surveys and so-called Living Standard Measurement Surveys that have indicated that macro-economic reforms and greater openness of African economies can lead to improvements in living standards (World Bank, 2002). They also include the World Bank's Regional Programme on Enterprise Development (RPED) that surveyed firms in eight African countries. These surveys supported recent policy implications of the endogenous growth literature 5 but also supported the macro-economic evidence of the cross-country regressions as far as suggesting the importance of lowering the riskiness of the African environment and of opening up African economies to foreign trade. Cross-country growth regressions have been popular in economics since the revival of growth theory and the rise of the so-called endogenous growth theory, see for instance Barro (1991) and Sala-I-Martin (1997). In these regressions, which are typically run using some adaptation of the Solow-model, the dummy variable for "Africa" as a region was initially consistently significant. A number of authors (e.g. Easterly and Levine, 1997) expanded the set of variables in order to account for this "African dummy". They found that six broad sets of variables were significant in explaining the African dummy, namely •

The lack of social capital in African communities coupled with high levels of ethnic diversity;

•

The lack of openness to trade;

•

Deficient public services;

•

Africa's geography and high riskiness of investment in Africa;

•

The lack of financial depth of African economies;

•

Africa's high aid dependence;

From the perspective of regional integration, many calls for regional integration amongst African countries in recent years have been motivated by the finding that African economies need to be more open to international trade. 5 These are that four broad avenues of policies could raise economic growth, namely policies that ensures (a) learning by doing (Romer,1986), (b) human capital formation (Lucas, 1988), (c) research and development (Aghion and Howitt, 1992) and (d) public infrastructure investment (Barro, 1990).

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Thus, regional integration is seen as a reciprocal way of lower trade barriers, but without subjecting previously sheltered industries to the full force of international competition. Although it will be argued that this policy prescription is wrong, the diagnosis is correct and there is now a significant consensus that one of the most serious causes of Africa's slow growth has been its lack of openness to trade. As noted by Jenkins and Thomas (1999) with reference to the cross-country regressions "Almost all of these concerned exclusively with Africa find that impediments to trade have been detrimental to growth performance, reducing the annual growth rate by between 0.4 and 1.2 percentage points". In the regressions of Sachs and Warner (1995) openness to international trade is based on a composite indicator consisting of the size of tariffs, the extent of non-tariff barriers, the difference between the black market and official exchange rates, the type of economic system, and the extent of state control over major exports. Sachs and Warner (1995) find that most of the countries in Africa were effectively closed to international trade for the 25 years from 1965 to 1990. Only Botswana and Mauritius were "open" for any length of time. The lack of openness was especially negative as far as it contributed to the failure of manufacturing in Africa. This is firstly because closed economies meant that the input prices of capital and intermediate inputs were above world market prices. Secondly, the closed domestic markets were small, preventing scope for either economies of scale or domestic competition. As a result, African manufacturing firms remained inefficient, which in turn caused reduced investment and skills formation (Jenkins and Thomas, 1999). The overall impact of this vicious cycle is the low growth rates in Africa and the inability of African countries' per capita incomes to convergence to levels of other countries. Ng and Yeats (1999) found that in Africa, countries that adopted less restrictive governance and trade policies were in fact able to achieve significantly higher levels of per capita GDP as well as higher growth rates for exports. Many countries have embarked on regional integration as a "reciprocal" manner to liberalise trade - as opposed to unilateral trade liberalisation. In this light, it can be understood that from an economic point of view, calls for African regional integration in 2000 are different from the calls that were made for African regional integration in the years immediately after independence. Then, the calls were made based on arguments for larger markets, as well as political arguments. Today the calls are made to ensure the opening up of African economies (Collier and Gunning, 1995).

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4.3 REGIONAL INTEGRATION IN AFRICA Most of the current regional integration groupings in Africa have been in existence for over 30 years. The major regional economic integration agreements in Africa are summarised in Table (4.1.) Table 4.1 shows that there are currently 9 major regional integration schemes in Africa. In order to assess the feasibility of a "United States of Africa" one must judge the success of these schemes in contributing to the economic development of their member states. A large literature exists on regional integration in Africa (see e.g. Yeats, 1998). From this literature, it seems fair to draw out the following "stylized facts" of African regional integration. First, despite decades of regional integration agreements intra-regional trade still comprises only 12% of total African exports. Second, in the trade patterns amongst African countries, trade between only 5 countries completely dominates intra-African trade (excluding South Africa). These are Cote d'lvoire, Nigeria, Kenya, Zimbabwe and Ghana. Together the trade between these 5 countries account for over 75% of intra-regional trade. Third, four products dominate African intra-regional trade. None are manufacturing goods but all are commodities namely petroleum, cotton, maize and cocoa. These commodities are responsible for 50% of intra-African trade. Fourth, despite decades of regional integration, the percentage of intraregional trade in Africa has not increased significantly. In other words, there is little evidence that regional integration in Africa has lead to trade creation. Table (4.2) below summarized the percentage share of intra-regional trade in the various regional integration groupings in 1970, 1985 and 1993. Table (4.2) indicates that in over 30 years, the movement towards regional integration has done little to contribute to trade amongst African countries. In major groupings such as the PTA and SADC, trade has actually declined in percentage terms. This suggests that African countries' trade with the rest of the world has been increasing must faster than intra-regional trade. Other evidence seems to suggest that this integration of Africa with the rest of the world (outside Africa) is not only a pattern in trade in goods, but also in terms of capital markets - for instance through capital flight from the continent. It has been estimated that up to 30% of the wealth of Africa could currently be held outside the continent. Fifth, if one considers the imports of SSA countries, almost 75% of this consists of capital goods such as machinery and transport equipment. The current economic structure of SSA countries is such that they have very little capacity to meet these needs and many African countries show a Revealed Comparative Advantage (RCA) in the same products. In other words, there seem to

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Table 4.1. Regional Integration Agreements in Africa

4 THE GLOBAL INTEGRATION OF AFRICA REGIONAL GROUP CIIPGL ECCAS

1970

1985

1993

0.4% 2.4%

0.8% 2.1%

l.luo

2.5%

ECOWAS

3.0%

5.3%

8.6%

MRU PTA

0.2% 9.6%

0.4% 5.5%

0.0% 7.0%

SADC

5.2%

4.7%

5.1%

UDEAC

4.9%

1.9%

2.3%

UEMOA

6.4%

8.7%

10.4%

79

Table 4.2. Percentage Share of Intra-Regional Trade in Africa, 1970-1993 be very little motivation for African countries to trade with one another given the lack of complementarity in trade patterns. The above overview of regional integration has shown that regional integration in Africa is unlikely to lead to substantial trade between African countries. As supported by Yeats (1998) this make less compelling arguments that regional trade can help overcome problems of small domestic markets in African countries. Moreover, if the contributions from the new theory of regional integration are correct, then indeed regional integration may present Africa with a lose-lose situation. These will be outlined in the next section.

4.4 AFRICA AND THE THEORY OF REGIONAL INTEGRATION Viner (1950) had made the economics of regional integration the classic contribution towards understanding. Viner coined the terms trade creation and trade diversion to determine in which instances it would be beneficial for countries to engage in regional integration. Baldwin and Venables (1995) contain a good overview of the subsequent literature on understanding trade creation and trade diversion. The practical experience of various regional integration agreements has supported the implication in Viner's and other's work that the effect of regional integration on the welfare of a participating country may be ambiguous. Venables (1999) point to the experience of the EU where regional integration has led to convergence of per capita incomes amongst member states. However, in ECOWAS and other agreements regional integration has led to divergence in per capita incomes.

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To predict whom gains and who loses in a regional integration agreement, Venables (1999) has recently integrated two strands of research, namely research on the comparative advantage of countries and research on the importance of agglomeration forces. With reference to the former strand of research, Venables (1999 p: ii) concludes: "Typically, the country in the free trade agreement (FTA) that has comparative advantage most different from the world average is most at risk from trade diversion. Thus, if a group of low income countries form an FTA, there will be a tendency for the lowest income members to suffer real income loss due to trade diversion. In contrast, if an FTA contains a high income country (relative to other members and to the world average) then lower income members are likely to converge with the high income partner." Venables' contribution to incorporate agglomeration forces into the understanding of regional integration is a useful contribution that contains vital insights from the so-called new economic geography. Given the great concern in Africa about the continent's lack of manufacturing development, it is necessary to provide a more detailed explanation. Regional integration may lead to welfare-inducing changes in the agglomeration of economic activities in member countries. This is because regional integration (through for example a FTA) makes it easier to supply consumers from a few locations. This would lead to the relocation of industries in either one of two ways, each with different implications for convergence of divergence of per capita incomes between countries. The first is when the regional integration causes particular sectors to become more spatially concentrated - e.g. a certain country experiences an agglomeration on financial services, another of manufacturing enterprises, another of commercial agriculture, etc. In such a case, despite adjustment costs, the net effect of regional integration may not necessarily be greater inequality between countries. If however, regional integration leads to manufacturing as a whole to cluster in a few locations, it may lead to the de-industrialisation of less-favoured regions. This will lead to divergence in per capita incomes amongst member states. As shown by Venables (1999) this is more likely to occur if manufacturing as a whole is a small share of the economy - as in most African economies. The agglomeration forces described above may interact with competitive advantage forces. Specifically, agglomeration may accentuate the competitive advantage force in the direction of divergence in the case of developing countries (Venables, 1999).

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The conclusion from the above analysis, when combined with the stylized facts on African regional integration is that regional integration schemes amongst African countries could lead to divergence in incomes due to agglomeration forces, as well as the comparative advantages that will be enjoyed be only a few countries. Schiff (1999) extends the theory of regional integration by asking not whether regional integration should be pursued or not, but that if it is persued, what criteria should be used by countries to decide on a partner country or block. This question is relevant in the present context, since if it is the case that regional integration amongst African countries could lead to divergence in per capita income, and regional integration with higher income countries are preferred, the decision should be made with what country? Schiff (1999) shows that pre-FTA (Free Trade Area) volume of trade is not a useful criterion for selecting a partner bloc. Instead he concludes that: •

A home country will be better off with a large partner country (or bloc). This is because a large partner country is more likely to satisfy the home country's import demand at world prices. Thus for SADC countries it will be better to integrate with Euroland that South Africa.

•

The FTA as a whole is likely to be better off if each country imports what the other exports (rather than each country importing what the other imports, as was shown in section 3 to be the case in Africa).

The recommendation from the above is that African countries should pursue unilateral trade liberalization on a most favoured nation (MFN) basis as a preferred strategy to regional integration, with a FTA with a higher income region the second option. However, it must be added here that this does not mean that regional integration groupings such as those listed in section 3 should necessarily be abandoned. There is a strong case to be made for the maintenance and expansion of these. This is because there is empirical evidence that significant "neighbourhood" effects exist in Africa. Easterly and Levine (1995) has found that there are significant spillovers of growth performance between neighbouring countries in Africa. They conclude that if neighbouring countries in Africa act together to improve economic policies and political stability, the effects on the growth rates of all are much greater. Specifically, the results suggests that the effect of neighbours adopting a policy change (e.g. opening up trade) is 2.2 times greater than if a single country acted alone.

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4.5 THE SOUTH AFRICAN-EUROPEAN UNION FREE TRADE AGREEMENT The establishment of the South African-European Union free trade agreement (SA-EU FTA) embodies a milestone in history. For the first time a FTA incorporates an overall concept of development and cooperation. Literately, the protocol is named an Agreement on Trade, Development and Cooperation (TDCA) which is premised on democratic, human rights, and rule of law principles. It involves different economical and societal realms, which will provoke South Africa's economy to compete on a global scale. The Agreement reflects a new approach towards North-South economic integration. As Keet (1996) puts it, this form of integration will function as a pilot project which, if successful, could equally be projected onto other countries. From its' initial talks to its final implementation a period of four years had passed before the Agreement went into force by 1st January 2000. Admittedly, spurred by the political reforms in 1994 South Africa commenced opening up its economy by joining SADC and gaining access to the most preferred conditions under the Lome Convention6. Not surprisingly, the EU first turned down the access to Lome for South Africa in November 1994. EU's major reasoning was that South Africa would not suit as a strong, developed and middle-income country among the other 70 member nations. However, the EU was aware of South Africa's landmark within the Southern African economic environment and hence admitted South Africa to Lome under a qualified membership status in 1997. In reality, South Africa was already granted access to the Generalized System of Preferences (GSP) and hoped to climb up all tiers of the EU's pyramid of privilege in order to gain best access conditions to the European market. Despite all concessions and the twin-track approach by the EU a bilateral reciprocal free trade agreement was proposed to South Africa in 1995. The SA-EU TDCA promotes a framework for an unlimited period of cooperation between the two parties. A mutual Cooperation Council will be established to settle any disputes like anti-dumping and intellectual property issues arising from the Agreement. It will also review latest developments 6

A European Union preferential trade arrangement and multilateral development aid program with the ACP countries (most of the former European colonies) to allow for free trade access to the European market (Lome I signed in 1975). Lome functions as an unilateral trade concession from the EU to all Lome members. In addition, international loans by the European Investment Bank (EIB) and development aid are available.

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and pursue further trade liberalization. Additionally, the free movement of commodities and capital including the free flow of trade in services are the objectives of the FTA. eralion Agreemtnl bctwecn SA - EU 1 i*,U. 1 j L velopmen t a'nä' 'Coop Development of Free Trade Area Economic Cooperation Trade Cooperation Social & Cultural Cooperation

Institutional framework Development Cooperation Financial Assistance Political Dialog

Table 4.3. Main Aspects of the SA-EU Free Trade Agreement Source: Bundesstelle für Außenhandelsinformation, 1999.

•

Economic Cooperation

Article 50-64 enumerate the fields of cooperation in postal, energy, mining and minerals, transport, tourism, agriculture and fisheries, services, consumer policy and protection of consumer health. It promotes and assists domestic industry, investment and tries to avoid double taxation. Finally, information and telecommunication technology will be provided. •

Development Cooperation

Development of sustainable private enterprises for regional cooperation and integration, with focus on neglected communities, genders and environmental dimensions as well as support of progressive integration into the world economy are ratified in Article 65-82 in the protocol just like the essential expansion of employment. •

Trade Cooperation

Trade development means transfer of know-how and technology through investment and joint ventures. The exchange of information and the promotion of small and medium sized enterprises (SMEs) will have priority. Other fields of cooperation include environmental, cultural, societal and health issues to provide necessary support at every stage of the society and upgrade SA's status. Gundlach (2000) suggests that in order for free trade to be welfare enhancing trading partners do not have to liberalize all at the same time. Thus, the SA-EU FTA has implemented the principle of asymmetry and differentiation. In this context, the EU has committed itself to liberate its tariffs at a faster pace than South Africa. Specifically, the EU is going to liberalize 95 percent of its South African imports over a period of 10 years whilst South Africa will do so for 86 percent respectively. Of course, the reciprocal process of liberalizing tariffs on bilateral trade has to be in accordance with the WTO rules on

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FTAs that asks for the abolishment of duties on substantially all trade over the period of 10 years. Again, most South African commodities already entered favourably the EU under the GSP conditions. For example, 57 percent of South African exports to the EU in 1997 entered the EU market duty free on a MFN basis and 28 percent enjoyed GSP status. Consequently, a total of 85 percent enjoyed free market access prior the TDCA. Notably, 20 percent of agricultural and 80 percent of industrial products were eligible for duty free provisions. It follows that the EU does not have to liberalize at the same degree as South Africa. As a matter of fact, SA will have to get rid of 86 percent of its total imports from the EU due to the TDCA as Davies (2000) explains. Since the Agreement focuses on tradable and non-tradable goods, it remains to be emphasised that the major attention was directed towards industrial and agricultural products. Between the two product groups comparative advantages of trading partners are reflected. South Africa advantages lie in natural resources, textile, agricultural produce, and wine and in the vehicle assembly production and a diversified pool of human capital, whereas EU's edges are in technology, skills and capital. Apparently, the EU with its 15 member states incorporates a very protected and subsidized agricultural sector, run by its Common Agricultural Policy (CAP). In light of the established agreement it is interesting to recall the findings from the IMF Staff Country Report on South Africa (2000) which argues that about one-fourth of all tariff lines which are exempted from tariff elimination are in sectors of the highest tariffs. To foster South Africa's location advantage decisive intellectual rights, antidumping, safeguard, repatriation possibilities and investment protection where also taken into account of the Agreement. Equally important are the special reserve lists or negative lists. Issues on port and sherry, fisheries, cut flowers, footwear and tyres as well as the automobile industry regulations culminated in tough rounds of negotiations even after the ratification of the protocol. For these sensitive products particular tariff quotas were established. Davies (2000) argues that in terms of success in the negotiations, South Africa brought down the percentage of agricultural products excluded from the TDCA from 46 to 26 percent. With respect to Jovanovi (1992) who postulates that free trade areas tend to include manufactured goods but neglect agricultural products in general such an achievement needs to be stressed. Rules of origin prohibit the deflection of trade and make up for the special feature of FTAs. They describe the local content of a product originating in a member country. They are not only about customs control, but about

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economic development, jobs and investments Smalberger (2000) noticed. The instrument of cumulation of rules of origin allows to source inputs, to a certain degree, from other countries. In that regard, the TDCA provides for diagonal/partial cumulation between the EU and SA but also among SACU and ACP states. Furthermore, an applied tolerance rule of 15 percent permits to source from third countries except for products like textiles, fish, tobacco and alcohol. To make explicit statements on the possible impacts from the established FTA it needs to be recapitulated that the tariff phase down will run until 2012. Even then, there will be further negotiations on pending duties. Hence, only general assumptions can be stated. Also, at this stage the outcome from NAFTA, for example, can only be evaluated in the medium run since it will phase out in 2004. In this context, economic literature offers mainly ex-ante rather than expost analysis. Notwithstanding, Teljeur (1998) employed the static and partial equilibrium SMART model which is a simulation tool provided by UNCTAD to gauge the quantitative impacts caused by the SA-EU FTA. It chiefly focuses on the tariff liberalization and neglects other forms like rule of origin, non-tariff barriers (NTBs) and physical quotas. Generally, it also lacks the dynamic effects of FTAs which need to be taken into consideration when discussing trade creation or trade diversion effects in real terms. For it is acknowledged that dynamic and geopolitical advantages offset the direct and static costs of such an Agreement. It was found that the trade creation effect would not significantly impact on South African exports. The negotiated tariff reductions are prone to induce only 0.8 percent of additional trade. In comparison to a potential rise between 2.3 to 12.3 percent share for the EU's respectively. Moreover, it is believed that South African imports from the EU will surmount its' expected exports. It is criticized that 135 very trade sensitive commodities which account for much as 50 percent of South African farm products were expelled from tariff reduction. Despite the fact that SMART is limited to merely import and export projections, it nevertheless offers a sound tool for specific trade negotiations. There is a wide discussion on South African adjustment costs emanating from the Agreement. Davies (2000) also expects revenues from customs duties to diminish on a large scale due to the removal of duties on total imports. Concurrently, training and development is necessary to secure a smooth operation of the customs regulations like the handling of statistics, disputes, etc.

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The TDCA provides opportunities especially for the manufacturing industry. Davies (2000) enumerates steel and steel products, ferro alloys, aluminium products, furniture and automotive products as potentially significant beneficiary industries. Possibilities of establishing completely new industries to produce for the EU, South African and SADC markets will also be opened up by the Agreement. This will entail high potential for both domestic and foreign investors in industries to utilize SA as a platform for entry into the European market. The main trading countries in Europe with South Africa listed by importance are inter alia: Germany, the U.K., Netherlands, Belgium, Italy, and France. Germany accounts for almost 40 percent of SAs' imports and about 420 German firms are located in SA. The trade flows in the last decade presented in Figure 4.1 also point out that despite a constant trade balance of 2 percent on total trade with Africa, South Africa benefited from its German trading partner in terms of rising imports. In 1999, German imports rose 17.2 percent to DM 4.9 billion compared with the previous year, and a 3.1 percent slowing in exports could be reported the by Bundesministerium fur Wirtschaft (1999a) (German Ministry of Trade and Commerce) respectively.

German Imports/Exports with South Africa 7000

:

6000

rExports

s

c 5000 o

1 4000 ~ 3000

^ ^ • ' • ^ ^ ^

^——

_^ " * ^

Imports

2000 o en

00

IO 00

o>

o en en

CO 05

co

CO

in CO

CO en Years

CO CO CO

s. CO CO

00 CO CO

CO CO CO

Fig. 4.1. German Trade Development with South Africa

Source: Bundesministerium fur Wirtschaft 1999b, pp. 96-97; Michler, Walter 1991, p. 47; Statistisches Bundesamt 1995, p. 133; a= Statistisches Bundesamt 2000, p. 285.

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In retrospect, from 1996 to 2000 South Africa progressed significantly in terms of its competitiveness as the Global Competitiveness Report 2000 by the World Economic Forum shows. South Africa moved from 43th to the 33th place among listed members. Economist derive the surge and alteration of its export composition in macroeconomic terms due to the general export incentive scheme (GEIS) from 1990 and more recently from the growth, employment and redistribution programme (GEAR). Importantly, Davenport and Page (1991) noted that any trade diversion effect will have essential consequences for investments in general. They assert that investment in developing countries has mainly taken place to capitalize on natural resources or to supply rapidly growing local markets. Relative advantages over competitors is said to be realized particularly in industrial products which already cover 86 percent of South African outright export. Jenkins and Naude (1996) noted that South Africa's membership of SACU and SADC does not necessarily deter South Africa to enter into an agreement with the EU or other trading blocs. Hence further regional integration of South Africa can be expected in the near future. The establishment of a FTA among SADC members before 2004, and the possibility of signing a FTA with MERCOSUR are two examples. Jenkins and Naude (1996) argue in favour of the SA-EU FTA. Improvements in welfare, trade diversification, protection from anti-dumping suits and they predict more favourable rules of origin. They further assert that the FTA will create welfare gains for the whole of Southern Africa. It is further suggested that South African neighbouring countries should support the SA-EU FTA as it will furnish benefits in form of surging investments and two-way trade. In this context, Harvey (2000) names five fundamental insights which are due to a study conducted by the Institute of Development Studies (IDS) in the United Kingdom and the Botswana Institute for Development Policy Analysis (BIDPA). Initially, a greater competition within the SACU market and for the BLNS7 production exports caused by EU imports might occur. Equally significant is the potential customs revenue loss, the indirect impacts on the changing of South Africa's economy, and finally the altering FDI flows to BLNS countries. Yet, the overall effects have been found to be relatively small, besides the possible loss of customs revenues; Davies (2000). Adjustment costs for the BLNS states engendered by the increasing competition will also be partially compensated and taken into account during further ACP talks by the EU. 7

BLNS refers to the following countries Botswana, Lesotho, Namibia and Swaziland.

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Certainly, companies in either South Africa or the EU will have to face the impacts on the Agreement. First and foremost, for the EU South Africa is the most important trading partner in Africa. These relations will tighten and allow European companies to capitalize on the demand for diversified commodities in South Africa. Joint ventures, mergers and acquisitions (M&As) as well as takeovers offer sound possibilities for expansion. Apart from technology transfer export activities will improve. Table 4.4 shows the pro and cons for corporations due to the bilateral agreement. Advantages

Disadvanta»es

Access to the EU market for an unlimited time frame

Increasing imports from the EU

Cooperation FTA

Non-tariff barriers (NTBs) are

Development Assistance

not explicitly addressed

Upgradiög of Trading System

Threat of hostile takeovers, M&As

Provides FDIs for expansion

Efficiency of S As customs work

Entail new industries Increases Competitiveness Creates new opportunities Table 4.4. Corporate Implications of the EU - SA TDCA Source: Van Heerden (2000:96).

Valentine and Krasnik (2000) identified specific export sectors for South Africa and SADC countries based on Balassa's formula of comparative advantages. They found that nearly 50 percent of the total SADC trade, in terms of weighted annual growth rates, were destined for Brazil, China and India. In turn the growth rate of the EU and USA presented only low rates. The butterfly strategy, developed by the Department of Trade and Industry in 1996, reflects South Africa's international integration want. Eastwards India, Ocean Pacific and Asian countries are targeted. Westwards South American, Latin and Atlantic countries open up new opportunities. Most importantly though, its orientation to Africa and Europe will push South Africa to become more competitive in other markets. Most importantly, Valentine and Krasnik (2000) list countries by comparative advantages of export commodities, which could be a source for increas-

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ing export revenues. In particular, transport equipment, petroleum products, non-metallic mineral manufactures, manufactured fertilizers, furniture, essential oils, crude rubber, dyeing and tanning, and cereals are identified sectors showing improving status. In that regard, the top five sectors found by Valentine and Krasnik (2000) are machinery and transport equipment; electrical and office machinery; miscellaneous edible products; and essential oils and perfume materials. Also Wakeford (2000) foresees great business potential especially in herbal, indigenous, and homeopathic remedies as well as in the mix of cultural groups which support and maintain great opportunities for eco-tourism. These sectors are also seen to prosper further from the access to the European market. Strategically, South African companies will have lower trade barriers than firms located outside the FTA. This will according to McCarthy (1999) enable businesses to expand, distribute and diversify production. Additionally, he assumes that "agglomeration economies will.. enablefirms,especially those that produce relatively high value, low mass products, to sell in the larger (European) market regardless of the transport costs involved." Transport and shipping entities such as airports, sea freight and land transport businesses will entail fundamental changes. Like other recent studies, a study conducted by the African Development Bank in 1993 identified Tanzania, Zimbabwe, Zambia, and Angola with chemicals, Pharmaceuticals, paper and board, fabrics, metals, machinery, cars, and furniture as growth segments for Southern African trade in terms of the African market. The perception of the FTA from German MNEs in South Africa is demonstrated in a qualitative study provided by Bauer (2001). His general acquired insights are gathered here: • • • • • •

Companies did not regard the Agreement as very important for their business. Strategic planning will not be effected by the impacts of the FTA. The trade cooperation and economic cooperation appears to be of utmost significance, for the current trade between the South Africa and the EU is perceived as trade restrictive or trade neutral. All companies believed that the Agreement will have an positive or neutral effect on South Africa's economic development. Most businesses are not sure about improvements in employment, only few are determined that the FTA will encompass an effect on job creation. An increase in FDIs can be expected in 2005 by German companies which coincides with the first reviewing of the SA-EU FTA.

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•

Most beneficiaries of the SA-EU FTA are the following industries by importance: (1) tourism, Pharmaceuticals, telecommunication; (2) airports8, security services, manufacturing and agriculture; and (3) computer industry and banking. • Tourism entails most opportunities together with the automobile, chemical, trading and consumer goods industry like food and nutrition. • Negative impacts for the SADC members are expected to be of very low impact. Even the potential enlargement of the EU is not feared and viewed as a potential advantage for the South African economy due to the gain of further market access power. To conclude, the negotiated agreement incorporates a facet of societal, political and economical realms with the establishment of a mutual benefiting FTA at its heart. The SA-EU FTA proves to be of positive net benefit to South Africa, as it pertains a relatively developed and diversified industrial sector. Indeed, major export revenues are still being generated in the primary sector but there is a change in the trade composition already visible. Without doubt, the FTA with the EU will be a new initiative for the North - South economic relations. The conclusions from the findings suggests that German companies in Europe or South Africa benefit from the TDCA as trade between the partner countries will continue to increase. The introduction of the Euro in 2002 does also champion this argument. Opportunities in tourism, automobile and chemical industry are expected to prosper predominantly. But economic integration will be useless if, in the end, the dynamic effects will not result in an improvement of the social conditions on the premise of sustainable development processes.

4.6 PERCEPTIONS OF THE SA-EU FTA AMONGST GERMAN MNEs IN SOUTH AFRICA9 The questionnaire contains two sections. The first section asks for general environmental, business related and investment issues. The second section attempts to identify the corporate view of the EU-SA FTA and its efficiency. The questionnaire was mainly addressed to German companies operating in SA. The following summary will highlight some insights. Nevertheless, one needs 8

The increasing two-way inter-continental business interactions led to a surge in airway traffic valuing hundreds of billions of Rands a year. See Nevin, (1997:11). 9 The authors would like to thank especially Udo Meinecke from KPMG, Johannesburg as well as Ulrike Foschetti from the South African - German Chamber of Commerce and Andreas Berger from Gerling General Insurance of South Africa Ltd. Johannesburg who supported this quantitative study and facilitated some useful discussions with Siemens and Deutsche Bank.

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to be conscious about the qualitative value and its fundamental impact. Only an impression of the overall findings can be presented. Furthermore, primarily the outcome from the sections which were answered by all firms shall be enlightened. Initially, the nine responding firms shall be grouped into A, B, and C. Notably, each family contains three businesses. Group A refers to companies established in the 1990s. Firms founded in the 1970s and 80s are gathered in group B. Finally, companies of group C have been in South Africa since the 1950s and 1960s. For the purpose of this study the size of the company shall be ignored and section one shall be addressed merely briefly. The total outcome of all groups from the first section points out that onethird of all companies operate as a different type from its parent company in South Africa. Four out of nine firms showed great diversification and operate in various sectors of the market. Mostly machinery, chemistry, construction and consulting activities were marked. The overall trading activities tell that Africa (7), Europe (2) but also Arab and North American countries are the final destination of South Africa's exports. On the import side, Europe (8) and North America (4) are the major locations for sourcing10. South Africa's relative comparative advantage has been identified in marketing, inexpensive labor and location advantages. Six firms engage in exports and most companies characterized their investments as expansion oriented (4). Regarding investment activities four companies planned to engaged in investments in 2001 and the same amount planned to do so in 2005. This mirrors also the operative (4), tactical (1) and strategic (3) investment behavior. Local production (7), direct export (5), export via distributor (3) and irregular export (3) make up for the companies' prime activities. Here, the introduction of new products (8), cost minimization, increasing marketing and export (each 5) are the main corporate strategies for operating in South Africa. Of high importance to almost all firms are the qualification of its work force, the political stability, infrastructure and financial means like currency convertibility and expatriation regulations. The current economic situation of the firms covers the whole spectrum of all realms from excellent to risky and does not show a tendency. However, six firms foresee only medium potential of operating in South Africa, since the competition is viewed as very intense (3) and high (5). By groups, A's main activities are combined with consulting (2) and all three firms operate on a strategic investment plan. Interesting for group B was merely the perception to be exposed to a very intense (1) or high (2) competition. The same is valid for group C, yet they present a shift in their corporate strategies towards increasing imports form other markets, which may well had the EU-SA FTA as a trigger. 10

Various options could be marked at some questions thus the total number does not have to be nine all the time.

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Coming to the focus on section two and the quantitative results from the EU-SA FTA survey the first question regarding the knowledge of the Agreement showed that only four firms were familiar with its content. Partial (2) information or even no (3) information on the TDCA was also rather significant. Surprisingly, no firms regarded the Agreement as very important. Only three found it important, two less important and four not important at all. Therefore, it is understandable that five firms mentioned that they would not take the impacts of the FTA into their account for strategic planning. Just three companies will do so however only partially and one does totally. The trade cooperation (5) and economic cooperation (3) appears to be of utmost significance, for the current trade between the EU and South Africa is regarded as trade restrictive (3) or trade neutral (6). Nevertheless, all companies believe that the Agreement will have a positive (6) or neutral (3) effect on South Africa's economic development. Albeit most businesses (5) are not sure about improvements in employment, few (3) are determined that the FTA will encompass an effect on job creation. Benefits like technology transfer and a more competitive export price are expected to result within their companies. Potential detriments are increasing competition and a reduced mark up for operating firms. An increase in FDIs through the questioned firms can be expected in 2005 that coincides with the first reviewing of the EU-SA FTA impact. In this context, European (2) and African countries (2) were marked for countries seeking South Africa for FDI activities and market access. The four categories of infrastructure, education and training, crime reducing activities and housing stand out as urgent fields of society to be supported by EU's development projects. Most beneficiaries of the EU-SA FTA are the following industries by importance: Firstly tourism, Pharmaceuticals, telecommunication; secondly, airports11, security services, manufacturing and agriculture; and thirdly, computer industry and banking. In other words, the tourism sector entails most opportunities together with the automobile, chemical, trading and consumer goods like food and nutrition. Negative impacts for the SADC members are not expected and if then to be very low (5). Even the potential enlargement of the EU is not feared and genuinely viewed as potential advantages for the South African economy due to market access reasoning. By groups A shows similar opinion like the aggregate conclusions. In contrast to group B, a very pessimistic view to the impacts of the Agreement appeared. The current trade regulations were held to be very restrictive (2) or neutral (1) by group C. Moreover, they believe that the applied form of integration might be able to cause an increase in employment.

11

As mentioned above the increasing two-way inter-continental business interactions led to a surge in airway traffic valuing hundreds of billions of rands a year. See Nevin, Tom, 1997, p. 11.

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By and large, the results of this study give an ostensible picture of the perception of the FTA between the EU and South Africa by German firms in the Republic of South Africa. Despite the small number of returns it becomes clear from the earlier sections that trade between the two partners will promote EU's exports and South Africa's economic development. Relatively small detriments for SADC or SACU members are expected.

4.7 CONCLUSIONS This chapter critically assessed, from an economic point of view, the potential of regional economic integration amongst African countries for promoting economic development in Africa. It did so by considering the recent explanations for Africa's poor economic development and by assessing the African experience with regional integration. The insights from this analysis were combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. It may be concluded, with reference to the recent Free Trade Agreement between South Africa and the EU, that integration amongst African states may be sub-optimal to integration between African states and a higher income region (e.g. the EU). Specifically, regional trade agreements between SSA countries could be of limited value and could even lead to trade diversion and a divergence of per capita incomes amongst member states. Older arguments for African regional trade integration agreements centred round the lack of market size in individual African countries. However, given the WTO's GATT, the Lome Agreement with the EU and the Generalised System of Preferences (GSP), little external obstacles to finding markets for African countries' products still exists. The recommendations following from this paper is therefore that instead of first and foremost promoting regional integration and/or a United States of Africa that African policy-makers focus on the following: •

The liberalisation of import barriers on a most favoured nation (MFN) basis to increase the openness of their economies; • The concluding of a Free Trade Agreement (FTA) with high-income country (-ies) in the form of North-South regional integration. The South African FTA with the EU and possibility of extending this agreement to SADC offers a starting point. • The use of regional integration agreements not with the primary expectation of leading to increased trade or regional convergence, but to achieve

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W. NAUDE, W. KRUGELL and N. BAUER mechanisms of co-operation between African countries in terms of macroeconomic policy making and for providing a politically and economically stable environment to facilitate the repatriating of the huge amounts of African wealth currently held outside of the continent.

The advantages of the above strategy are that trade creation takes place that could facilitate convergence between African per capita incomes and that of the rest of the world, that Foreign Direct Investment and technology transfers are raised, that cheaper inputs needed can be sourced and that a lock-in (commitment) mechanism is created for reducing the risk of African countries reneging on trade liberalisation. It also alleviates the problems of negative neighbourhood effects in Africa. The call made in this paper is therefore that African states should focus on economic integration with countries outside of Africa for expansion of trade and for obtaining technology and investment, and should expect of economic integration agreements amongst themselves not to lead necessarily to greater trade, but to enhance economic policy co-ordination and the adoption and maintenance of sound macro-economic policies and governance practices.

REFERENCES Aghion, P., Howitt, P. (1992). A Model of Growth Through Creative Destruction, Econometrica, 60 :323-351. Baldwin, R., Venables, A.J. (1995). Regional Economic Integration (In: Grossman, G., Rogoff, K. eds. Handbook of International Economics, Vol. 3. Amsterdam : North Holland). Barro, R. (1990). Government Spending in a Simple Model of Endogenous Growth, Journal of Political Economy, 98(5) : 103-125. Barro, R. (1991). Economic Growth in a Cross-Section of Countries, Quarterly Journal of Economics, 106(2). Bauer, Norbert (2001). The EU-SA Free Trade Agreement - Impacts on German Multinationals, Unpublished Paper: University of Paderborn. Bundesministerium fur Wirtschaft (BMWi) (1999a). Deutscher Aufienhandel mit Afrika 1999, Baden-Baden: Koeblin. Bundesministerium fur Wirtschaft (BMWi) (1999b). Wirtschaft in Zahlen '99, Baden-Baden: Koeblin, Online available at URL: http://www.bmwi.de from 5 October 2000.

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Bundesstelle fur Aufienhandelsinformation (bfai) (Hrsg.) (1999). Siidafrika. Amtliche Texte. Abkommen iiber Handel, Entwicklung und Zusammenarbeit zwischen den Europaischen Gemeinschaften und ihren Mitgliedstaaten einerseits und der Republik Siidafrika andererseits, ZHI Nr. 28, Koln: bfai. Collier, P., Gunning, J.W. (1995). Trade Policy and Regional Integration: Implications for the Relationship between Europe and Africa, The World Economy, 18: 387-410. Collier, P. Gunning, J.W. (1999). Explaining African Economic Performance, Journal of Economic Literature, 37. Davenport, Michael and Page, Sheila (1991). Europe. 1992 and the Developing world, London: Overseas Development Institute. Davies, R. (2000). Forging a New Relationship with the EU, in: BertelsmannScott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 5 -16. Easterly, W., Levine, R. (1997). Africa's Growth Tragedy: Policies and Ethnic Divisions, Quarterly Journal of Economics, 112 (4): 1203-1250. Gundlach, Erich (2000). Globalization. Economic Challenges and the Political Response, in: Intereconomics. Review of International Trade and Development, Hamburg: HWWA, Vol. 35, May/June 2000, pp. 114 -126. Harvey, C. (2000). The Impact of the Agreement on BLNS, in: BertelsmannScott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 83 - 93. International Monetary Fund (IMF) (2000). South Africa. Selected Issues, IMF Staff Country Report, No. 00/42, March 2000, Washington, D.C.: IMF, Online Available at URL: http://www.imf.org. Jenkins, Carolyn, and Naud, Willem (1996). Reciprocity in Trade Relations between South Africa and Europe, in: Development Southern Africa, Vol. 13, No. 1, February 1996, pp. 17 - 30. Jenkins, C, Thomas, L. (1999). What Drives Growth in Southern Africa?, CREFSA Quarterly Review, 1: 2-11.

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Jovanovic, Miroslav N. (1992). International Economic Integration. Limits and Prospects, 2nd Edition, London: Routledge. Keet, Dot, (1996). The European Union's proposed free trade agreement with South Africa. The implications and some counter-proposals, in: Development Southern Africa, Vol. 13, No. 4, August 1996, pp. 555 - 566. McCarthy, C.L. (1999). Polarised Development in a SACD Free Trade Area, in: The South African Journal of Economics, Vol. 67, No. 4, pp. 375 - 399. Michler, Walter (1991). Weifibuch Afrika, 2. Auflage, Bonn: J.H.W. Dietz. Ng, F., Yeats, A. (1999). Good Governance and Trade Policy: Are They the Keys to Africa's Global Integration and Growth?, Policy Research Working Paper no. 2038, Washington DC: The World Bank. Nevin, Tom (1997). SA's Business Army on the March, in: African Business, June 1997, pp. 7 - 12. Romer, P.M. (1986). Increasing Returns and Long Run Growth, Journal of Political Economy, 94(5) : 1002-1037. Sachs, J., Warner, A. (1995). Economic Reform and the Process of Global Integration (In: Brainard, W., Perry, G. eds. Brookings Papers on Economic Activity, 1.) Sachs, J., Warner, A. (1997). Sources of Slow Growth in African Economies, Journal of African Economies, 6(3). Sala-I-Martin, X. (1997). I Just Ran Two Million Regressions, American Economic Review, Papers and Proceedings, 87(2). Schiff, M. (1999). Will the Real Natural Trading Partner Please Stand Up? Policy Research Working Paper no. 2161, Washington DC : The World Bank. Smallberger, Wilhelm (2000). Lessons Learnt by SA during Negotiations, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 48 - 51. Statistisches Bundesamt (Hrsg.) (2000). Statistisches Jahrbuch 2000, Stuttgart: Metzler - Poeschel.

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Statistisches Bundesamt (Hrsg.) (1995). Landerbericht Siidafrika 1994, Stuttgart: Metzler-Poeschel. Teljeur, Ethl (1998). Free Trade. Does South Africa gain? Impact of the Free Trade Agreement between South Africa and the European Union, in: Trade & Industry Monitor, Vol. 6, July 1998, pp. 1 - 6. Valentine, Nicole and Krasnik, Gena (2000). SADC Trade with the Rest of the World. Winning Export Sectors and Revealed Comparative Advantage Ratios, in: The south African Journal of Economics, Vol. 68, No. 2, June, pp. 266 - 285. Van Heerden, Neil (2000). Implications for South African Business, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 95 -98. Wakeford, Kevin (2000). The EU-SA Agreement. Opportunities and Challenges for Business, in: Bertelsmann-Scott, Talitha, Mills, Greg and Sidiropoulos, Elizabeth (eds.), 2000, The EU - SA Agreement. South Africa, Southern Africa and the European Union, South African Institute of International Affairs (SAIIA), South Africa: Print Inc., pp. 99 - 105. World Economic Forum (WEF) (2000). Global Competitiveness Report, Online available at URL: http://www.weforum.org from 15 September 2000. Venables, A. (1999). Regional Integration Agreements: a Force for Convergence or Divergence? Policy Research Working Paper no. 2260, Washington DC : The World Bank. Viner, J. (1950). The Customs Union Issue. New York. Yeats, A.J. (1998). What can be Expected from African Regional Trade Agreements? Some Empirical Evidence, Policy Research Working Paper no. 2004, Washington DC: The World Bank.

Part II

Multinational Enterprises in Africa

THE CHANGING VIEW OF MULTINATIONAL ENTERPRISES AND AFRICA B. M. GILROY University of Paderborn, Germany MGilroySnotes.upb.de

5.1 INTRODUCTION1 Since the seventies, international economic relations have increasingly gained importance. Presently, in addition to an increase in exports and imports, the expansion of business activities from different countries has particular importance. For example, the sales of multi-national businesses are higher than the international trade volume. According to preliminary estimates made by UNCTAD in their World Investment Report 2000, world foreign direct investment (FDI) inflows are expected to exceed US$ 1.1 trillion this year, up fourteen percent over 1999, representing a doubling in just three years. More than four fifths of this year's FDI inflows went to developed countries (see Table 5.1 below and UNCTAD Press Release (7 December 2000)). Western Europe continues to be the largest host region to FDI, receiving an estimated US $ 597 billion. FDI flows to Africa have risen modestly - from $8 million in 1998 to $10 billion in 1999 (UNCTAD (2000)). As some African countries, such as Angola, Egypt, Morocco, Nigeria, South Africa and Tunisia, have attempted to create business-friendly environments FDI has risen. In a recent survey of 296 of the world's largest MNEs carried out by UNCTAD and the International Chamber of Commerce at the beginning of 2000 South Africa and Egypt are viewed as the most attractive African locations (UNCTAD (2000), p. 9).

1

An earlier version of this chapter was presented as an invited lecture at the North-West University on the 14th March 2000.1 have benefited from the comments of the seminar participants as well as from the suggestions received by Prof. Willem Naude, Prof. Wilma Viviers, Prof. Thomas Gries, Prof. Karl-Heinz Schmidt and Norbert Bauer. Also important insights were gained from Andreas Berger of Gerling General Insurance of South Africa Ltd. The usual disclaimer applies.

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As Rubens Ricupero, Secretary-General of UNCTAD, recently reported business activities of multinational enterprises (MNEs), now numbering some 63,000 parent firms with around 690,000 foreign affiliates and a plethora of inter-firm arrangements and collaborations, spans virtually all countries and economic activities, making international business knowledge a growing necessity even for small and medium sized business enterprises.

1000

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000 (a)

• Developed countries

D Developing countries

D Central and Eastern Europe

D Developed countries

D Developing countries

• Central and Eastern Europe

Region Worldtotal Developed countries Developing countries Central and Eastern Europe

1990 209 172 37 1

1991 1992 1993 1994 160 172 226 256 114 113 139 145 43 55 81 105 3 4 7 6

1995 1996 1997 1998 1999 2000 (a) 331 399 473 683 982 1118 204 220 276 495 770 899 112 146 178 178 190 190 14 13 19 20 21 30

Source: UNCTAD, FDI/TNC Database a) Preliminary estimates on the basis of 50 major host countries (22 developed and 28 developing counWes] and Central and Eastern Europe as a region.

Table 5.1. FDI Inflows by Region, 1990-2000 As the international environment continues to change rapidly and become increasingly complex due to structural adjustments that open markets command, the demand for entrepreneurial spirits at all levels of the value-added chain of production is greater than ever. This chapter analyzes the changing view of multinational enterprises in the New World order and their possible effects on Africa. The underlying premise is that many of the activities which are so essential for the success of the new world order implies that African growth through regional integration must be carried out by the private sector, specifically the MNE. After a brief discussion of what a MNE actually is in Section 2, coverage of some highly stylized facts

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in Section 3 on the general changing views and theoretical perceptions held on MNEs are presented. Section 4 discusses the general impact of integration and the MNE on Africa. The shadow of AIDS on Africa and MNEs are examined in a short excursus presented in Section 5. The effects of property rights and potential growth for South Africa are proposed in Section 6, followed by a summarizing conclusion in Section 7.

5.2 WHAT IS A MULTINATIONAL ENTERPRISE? Multinational enterprises (MNEs) have often been denned in the literature simply as organisations that engage in foreign direct investment (FDI) and owns or controls value-adding activities in more than one country ( see e.g. Dunning (1974, p. 13), Dunning (1993/96, p.3), Casson (1985, p. 31)). Foreign direct investment is understood to be investment made outside the home country of the investing enterprise, but inside the investing enterprise. Control over the use of resources transferred remains with the investor (Dunning (1993/96, p. 5). McMannus (1972) pointed out that the essence of the phenomenon of international production is not simply the transfer of capital, but rather the international extension of managerial control over foreign subsidiaries. He argued that ownership-based control permits management to allocate resources more effectively than would be possible through the market. Value added simply represents the additional value created through the collective activities that occur as a product moves from raw materials through production to final distribution at each stage of the business process. Various other studies have defined multinationals in alternative ways (see e.g. Aharoni (1971), Lenel (1976), Macharazina (1981)). The editors, J. Stopford and J.H. Dunning, of the The World Directory of Multinational Enterprises(1982, 1992), for example, define multinationality according to three criteria: (1) at least 5 percent of consolidated sales or assets from foreign direct investment, (2) at least 25 percent of the voting equity in at least three foreign countries, and (3) at least $75 million in sales from foreign operations. The top 25 MNEs from developing economies, ranked by foreign assets in 1998 are illustrated in Table 5.2 below. Considering South Africa within this context as a "developing country" or more appropriately as an "emerging economy", Sappi Limited (Pulp and Paper) holds the sixth position and Barlow Limited (Diversified Equipment) position twenty-five. These two enterprises alone employ some 45,000 workers domestically in South Africa. The basic problem with a definition of multinationality is that there is no ideal gauge of foreign activity to suit all circumstances. The measure chosen will either be dictated by the data available or will depend on the question at hand (Clegg (1992)). In order to understand the current day phenomenon multinational enterprise, it is additionally necessary to examine more closely the enhanced usage of alternatives modes of mediating international transactions without equity cap-

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5 CHANGING VIEW OF MULTINATIONAL ENTERPRISES

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ital (the so-called new forms of internationalisation (Oman (1984), Gilroy (1988)) as well as the scope of equity investments of multinational enterprises. For example, as pointed out by Cargill and Shepard (1994, p. 24), after July 1991, when then President Bush lifted the 1986 ban on new investment in South Africa, of the 158 US companies with direct investment or employees in South Africa only 51 had set up subsidiaries. After July 1991, the number of US firms with licensing or distribution agreements, i.e. non-equity links, jumped from 184 to 448. As the operations of multinational enterprises become more multifaceted and heterogeneous, the commonly applied working definitions of what a multinational enterprise is have to a certain extent become outdated. All the same, the main advantage of the multinational enterprise, as differentiated from a national corporation, lies in its flexibility to transfer economic resources, information, knowledge and ideas internationally through a globally (or at least regionally) maximising network which offer an almost infinite variety of transactional options. Although much of the analysis of multinational enterprise is static (in the sense of placing emphasis upon the structural elements of plant location and the elimination of transaction costs at a discrete point in time), there is a rising awareness of the need to study analytically the operational flexibility and externalities present in a global network (see e.g. DeMeza and Van der Ploeg (1987), Buckley and Casson (1998)). There is a division of work in a network that means that enterprises are often dependent on each other. Their activities need to be co-ordinated. Coordination takes place through interaction among enterprises in the network, in which the decision variable price is just one of the several influencing conditions. Enterprises maintain a complex set of external ties with customers, suppliers and competitors. These external ties lead to a corresponding set of internal ties that link the various organisational parts of the enterprise and are necessary in performing transactions with customers. This network of ties (if efficiently structured) adapts rapidly to changing market conditions and customer needs giving the participants of the network a competitive edge. The internationalisation of production has given rise to modern industrialism, reducing the independence of the individual producer while simultaneously increasing the total product available through co-operative effort. Enterprise organisational structure indicates not only the span of responsibility and authority stressed in the transaction cost approach associated with Ronald Coase and Oliver Williamson (compare Figure 5.1), but also the key linkages that need to be maintained to conduct enterprise business in a dynamic and flexible global network. Simple transaction cost analysis may obfuscate various other cost elements which are important in the analysis of integration processes. Especially, the costs of organising, managing and controlling the hierarchical structures of enterprises may adversely influence their efficiency and capacity

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of adaptation, resulting in prohibitive costs of change (Courlet and Pecqueur (1991, p. 307)). Market Low Integrated Hierarchical Organisation

Transaction

Low

Costs

Market Costs of Change

Intermediate Network Forms

Fig. 5.1. The Effects of Transaction Costs

Source: Courlet and Pecquer (1991), p. 307 In the past the distinction between markets and hierarchies as modes of organising transactions appeared clear cut. Modern day enterprises exhibit, however, an increasing proportion of transactions through co-operation or affiliation between firms (Dunning (1993/96, p.91). Richardson (1972) pointed out that co-operation is more likely to appeal to two (or more) enterprises than a market or a hierarchical relationship when each engages in complementary but dissimilar activities. "Coordination of economic activity by cooperation is preferred to that by hierarchies as it involves lower transaction costs for organising dissimilar activities, whereas it is preferred to the market because coordination requires matching the plans of separate enterprises rather than matching aggregate supply to aggregate demand (which is the main task of markets) (Dunning, 1993/96, p.91)." Current day forces of globalisation have arisen in response to fundamental structural changes that have transformed production methods in world markets. World-wide sourcing strategies of multinational enterprises reflect the new international division of labour, that is, the movement from simple commodity exchange to international production and co-operative inter-enterprise service arrangements. Ghosal and Westney (1993) extend their definition of multinational enterprises therefore adding two other dimensions to the simple existence of activities in several countries: the presence of decision making

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centre(s) permitting coherent policies and a common strategy, and the existence of inter-linkages between the various entities within the MNE enabling them to exercise influence over the activities of the others. Ghosal and Westney (1993, p. 2) describe the MNE as "one of the most complex forms of organisation currently in existence."

5.3 THE CHANGING VIEW OF MULTINATIONAL ENTERPRISES: SOME STYLISED FACTS The enormous literature on the institutional phenomenon MNE has undergone rapid evolutionary changes throughout the years (see the twenty-five volumes of the United Nations Library on Transnational Corporations, e.g. Dunning (1992)). Significant theoretical contributions in the areas of international trade, industrial organisation, international finance, transaction-cost approach to economic organisation, business administration, taxation, and elements of law and political science have all been successfully applied to the domain of multinational enterprise analysis (compare e.g. Dunning (1993/96), Caves (1996), Helpman (1984), Ethier (1986), Cantwell (1991), Markusen (1984, 1995)). The world's view of multinationals during the early 1970s was basically one of "a global economic conspiracy perpetrated by the white men in dark suits who run the world's multinational corporations (The Economist, January 29*^ 2000, p. 19)." Books such as the American Challenge by Jean-Jacques ServanSchreiber (1993) (a French journalist and politician) originally published in 1967 are illustrative of the historical animosities against MNEs. At the time, the world was increasingly confronted with rapid expansion of foreign direct investment flows associated largely with American enterprises attracting extensive political criticism (Penrose (1996)). The atmosphere and emotions of this period concerning MNEs are well documented in the famous book by Raymond Vernon published in 1977 entitled Storm Over The Multinationals. At the time, Vernon wrote: "the multinational enterprise has come to be seen as the embodiment of almost anything disconcerting about modern industrial society." The volumes by Widstrand (1975) and Onwuka and Sesay (1985) give a critical account of this time period with special focus on MNEs in Africa. More recent contributions are Schmidt (1988), Mundorf (1992) and Blank (1996). During the early 1980s firms were increasingly referred to as "global" enterprises following competitive strategies on a "global" scale (Penrose (1996, p. 562)). As local governments increasingly perceived their national sovereignty being directly challenged by MNEs various attempts to regulate and control

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foreign direct investment activities were implemented during the 1980s. For example, countries were convinced that their freedom to set corporate taxes necessary to provide public services was being undermined by the multinational ability to shift profits and operations from one country to another. Indeed, MNEs do possess strategies to achieve competitive advantages in multiple tax jurisdictions as has been recently modelled by Singh and Hodder (2000) among others. The realities of transfer pricing strategies of multinational enterprises are reflected in the various titles of current day articles such as the recent focus survey in The Economist (January 29*^ 2000, p.3) entitled The mystery of the vanishing taxpayer. The amount of trade directly or indirectly associated to foreign direct investment has been estimated at 60 to 70 percent (Dunning (1994), Buckley (1998)). Such trade may be viewed, according to John Dunning as "connected transactions". The potential shift of welfare effects is evident. World trade flows based upon intra-firm trade have been estimated to be as high as fifty percent, which places control of prices within the scope of MNEs (Gilroy (1989a), Buckley (1998, p.13)). Many technology transfers occur simply between parent corporations and their foreign affiliates. Thus, the appropriability of the inherent information contained in the technology remains with the enterprise (Magee (1977)). Non-Governmental Organisations (NGOs) also have jumped on the bandwagon and voiced loudly their disapprovement of the various activities of many MNEs (compare e.g. Finger and Kilcoyne (1997), Gilroy (1999), Lobe (2000)). Anxieties based upon the perils of globalisation must be taken seriously since they could lead to new forms of protectionism and disintegration of world markets as politicians accede to accommodate their voters. To a large extent the anxieties associated with globalisation and employment, for example, are due to the stylised fact that the number of persons employed directly by MNEs has increased more slowly in the past decades than the growth in investment flows. Elements of corporate restructuring due to strategies of mergers and acquisitions often led to employment acquisitions rather than employment creation (Gilroy (2001)). Moreover, there are unfortunately enough cases of past detrimental activities of MNEs throughout the world which should indeed be condemned (compare Manu (1996)). However, as the process of globalisation and integration of world product and service markets continues to follow the inherent economic logic of economies of scale and scope and the new global division of labour, opinions have been changing or have adapted accordingly. In the July 30, 1990 edition of Fortune magazine one can read: "Now that the global village is truly upon us, it looks more like a global industrial park. We live in an expansive New World of economic interconnections where business roars through borders and time zones."

5 CHANGING VIEW OF MULTINATIONAL ENTERPRISES

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As the world becomes increasingly influenced by the appearance of newly industrialising nations as influential actors in global markets, along with the simultaneous rapid increase in technological and organisational advancement as well as the movement of a growing liberalisation of the world macro economic environment and the movement towards closer economic interdependence world-wide, current day perceptions of MNE activities are now much more favourable as summarised in the following citation from Dunning (1993/96, p. 545): "governments are increasingly viewing multinational enterprises as a means by which they can upgrade the competitiveness of their domestic resources and capabilities and evolve a pattern of development which is consistent with their long-term dynamic comparative advantage." It may be argued that government supports promoted e.g. by a national or state Industrial Development Agency to attract MNE investment can improve the overall development process. FDI is recognised as a major contributor to regional development (Young, Hood and Peters (1994)). For example, the provision of foreign trade zones, lower taxes, and job-creation subsidies have been shown to have had statistically significant effects upon the effectiveness of U.S. state promotion efforts to attract and benefit from strong agglomeration effects in Japanese investment (Head, Ries and Swenson (1999)). Throughout time, MNEs commonly contribute either directly or indirectly towards providing employment opportunities, enhancing the local standard of living and improving the tax base, which permits the financing of the original investment supports (Mudambi (1999, p. 67)). The role of the state in global competition is, however, still quite controversial (see e.g. Gilroy (1998), Buckley (1998)). Buckley (1998) has concisely discussed the debate on competitiveness as illustrated in Figure 5.2. The world economy is embedded in the international capital market. Underneath this are a series of more or less coherent regional groupings that pursue the harmonisation and integration of the goods and services markets while ensuing protectionist policies such as a common external tariff against the rest of the world. Below this tier, national governments endeavour to regulate labour markets in conditions where capital flows are directed by international differences in interest rates or rates of return on FDI. Commodity markets become increasingly regulated at the regional level. Consequently, this leads to a conflict of management of the world economy as the individual country struggle for their share of the world product.

110

B. M. GILROY Market

Capital Markets Capital Flows,

Goods and Services Markets

Management Conflict of national policies (i rate locational policies) Integration, harmonisation and protectionist regional policies

Labour services National employment training and fiscal policies

Labour markets

Fig. 5.2. Internalisation of Firms - Conflict of Markets

Source: Buckley (1998), p.13. Let us turn briefly to summarising some of the stylised historical theoretical developments on MNEs that have evolved under the changing perceptions of multinational activities along the lines of Figure 5.3. The basic starting point goes back to neo-classical theory which is primarily a theory of prices and the allocation of resources. The firm is interpreted essentially to be a "black box", i.e. factor inputs such as land, capital and labour are simply transformed by the given technology (production function) into final consumer products and services sold in perfectly competitive markets. What role then do firms play as economic organisations? R.H. Coase (1937) was one of the first modern authors to raise the question as to why firms exist? The answer he gave was that firms must be interpreted as internal markets for transactions that do not take place on external arm's length markets due to transaction costs which reflect the fact that external markets are not perfect. Given non-perfect markets, internal transactions allocated by fiat, i.e. administrative organisation through hierarchies, instead of simple price allocation may prove to be more profitable and cost-minimising due to "transactional advantages" over the market. The original studies focusing on MNEs and searching for an explanation of the phenomena are Penrose (1956, 1959), Dunning (1958), Behrman (1962),

5 CHANGING VIEW OF MULTINATIONAL ENTERPRISES THEORY OF THE FIRM (NINE) AND ECONOMIC ORGANISATION

N E O - C LASSICAL APPRO/C H

QUASI - CONTRACTUAL APPROACH

NETWC3RK APPRC)ACH

PRODIJCTION FUNC1ION

NEXUS OF CONTRACTS

NEXUS OF TREATIES OF STRATEGIC ALLIANCE

COMPETITION

COOPERATION

RECONCEPTUALIZATION OF THE MNE TO INCLUDE THE ECONOMIC LOGIC BEHIND THE OBSERVED ORGANISATIONAL STRUCTURES

HIERARCHICAL SOLUTIONS MAIN FUNCTIONS - CONTROL - MONITORING

INTERNALISATIONAL THEORY: - TRANSACTIONS COSTS - BOUNDED RATIONALITY - ASSET SPECIFITY - OPPORTUNISM/PRINCIPAL - AGENT PROBLEMS - UNEVEN DISTRIBUTION OF BARGAINING POWER ETC.

NON-HIERARCHICAL SOLUTIONS MAIN FUNCTIONS - ORGANIZATIONAL COORDINATION - SUPPORT/LEARNING - CREATION OF POSITIVE EXTERNALITIES APPROACH JOINT VENTURES PARTNERSHIPS STRATEGIC ALLIANCES

NETWORKS - PIVOTAL ROLE OF TRUST - INTENSITY OF COMMUNICATION - ROLE OF PERSONAL RELATIONSHIPS -LINKAGES AS A FORM OF 'SEMI-INTEGRATION' - LONG TERM STRATEGIC COOPERATION

PARTNERS AND RIVAL MODEL OF THE MNE AS AN OPTIMAL PORTFOLIO OF NETWORK TRANSACTION OPTIONS

Fig. 5.3.

111

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MacDougall (1960) and Kemp (1964). The advancement of the theory of monopolistic competition during the 1930s and Hymer's (1960) defiance of the capital arbitrage perspective of FDI flows being based upon relative differences in interest rates led to new insights. The basic (Hymer)/Kindleberger (1969) hypothesis is that a MNE must have some non-marketable advantage over foreign domestic firms that is sufficient to overcome the natural obstacles of operating in some distant foreign market. The relevance of Hymer's work is found in essentially every study of MNEs. As postulated by Dunning and Rugman (1985, p. 228), Hymer's contribution and great insight was in articulating the process of FDI as an international extension of industrial organisation theory. Along these lines of thought FDI was due to the existence of imperfect competition, product differentiation and barriers to entry. Thus, the common strand in the line of thought from Coase to Hymer is the notion of the firm as an internal market for transactions that are not economically permissible on spot markets. Given such transactional advantages of an internal market, the implication is that pure "market failure" exists or imperfect markets for other reasons. As pointed out by Penrose (1996, p. 562), such considerations still do not distinguish the MNE from domestic firms. The traditional model of enterprises starts with the assumption that the particular means of contributing financial capital to the productive unit will define the structure of the enterprise. The enterprise is thus an institutional scheme for organising the interests of "owners" or equity contributors (Milde (1987)). The specific class of capital contributors and its institutional conception (common ownership/shareholding) form the center of the organisational structure. All other inputs are integrated into this structure through specific "external" markets (the labour market, the market for technical and administrative know-how, the non-equity capital market, etc.). Some inputs are conceived of as being "physically" integrated into the enterprise (managers, employees) through special contracts (Schanze (1986)). This traditional enterprise model has been further developed, analysing the enterprise as a "set of contracts" or a "nexus" perspective of the enterprise (Reve (1990), Alchian and Demsetz (1972), Jensen and Meckling (1976)). This nexus model of the enterprise discards the notion of a vested priority of one specific asset. Rather, it stresses that all input/output relations should be analysed as interlocking functions of the enterprise concept (compare e.g. Schanze (1986), Johnston and Lawrence (1988)). The nexus model, however, fails to explicitly recognise the value-added effects of international networks. Along the lines of the nexus model, the "constitution" of the enterprise is defined by the constitution of institutional "interfaces" of the various input/output relationships (Schanze (1986)). The initial nexus model as proposed by Alchian and Demsetz (1972) and Jensen and Meckling (1976) relies

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solely on a contractual interface. Input/output relations are described through contractual arrangements. However, as mentioned above, the importance of non-contractual interfaces and relationships has also been observed in the literature. Williamson, Wachter, and Harris (1975), for example, have argued that the characteristics of internal labour markets give the organisation efficiency advantages over alternative institutions. Radner (1975) has discussed the performance and survival implications of simple rules for allocating managerial efforts. Rules may substitute for full optimality, since sheer complexity makes its obtainment impossible. Boorman (1975) has analysed the equilibrium and welfare properties of informal networks of ties that permit information acquisition to individuals, the need for which arises randomly. The importance of such effects for corporate networking has been emphasized e.g. by Mueller (1986). Transactional diversification through contractual or relational arrangements often represents an entrepreneurial mechanism for capturing potential integration economies (economies of scale, economies of scope and ray economies) associated with the simultaneous supply of inputs common to a number of production processes geared to distinct final product markets (Teece (1980, p. 224)). For example, inter-enterprise collaboration in basic research in nonstabilised frontier technologies occur to the extent that no single enterprise can solely bare the costs of such research, and yet no enterprise can risk losing access to a new technology that membership in a research and development pool potentially provides. It has been observed in the literature that especially research and development facilities have become increasingly regionalised (see e.g. Mytelka (1987), Burstall and Dunning (1985), Cantwell (1988), Cantwell (1996) Santangelo (2000)). Local entrepreneurial competitiveness attracts global competitors, resulting in the clustering of multinational enterprise activities. Locally embedded value added and the subsequent localised knowledge spillovers resulting from it create spatial agglomeration economies, which generate competitive enterprise advantage based on untraded externalities. Markusen and Venables (1999) have demonstrated that through such linkage effects FDI acts as a catalyst which generates the development of local industry such that domestic firms may one day reduce both the relative and absolute position of MNEs in the industry. The welfare gains are unambiguous. The important aspect hereby is that active co-operation inter-enterprise network structures through "New Forms of Internationalisation" in no way diminishes the private appropriation of quasi-rents. Rather, it is much more the case that "externalizing" various transactions internationally through interenterprise collaborative agreements liberates funds for further development activities that are more likely to enhance an enterprise's competitive position (Mytelka (1987)). Arrow (1975) has demonstrated theoretically that vertical integration can generate better information, increasing profit level when input supply uncertainty exists and when an investment type decision is of an ex

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ante nature. He demonstrates further also that an upstream industry can appropriate the benefits of better information by giving the information to the downstream industry. Thus, while vertical integration is sufficient, it is not always necessary. The possibility of a division of labour between enterprises and the importance of mutual exchanges of information has long been recognised by economists since Alfred Marshall's analysis of "industrial districts". Framing the phenomenon of know-how trading among rivals within the context of a prisoner's dilemma, Von Hippel (1989) has also studied what he terms "collective invention" and reciprocity. His data show that individuals and enterprises commonly revealed information of apparent competitive value to both existent and potential rivals based upon reciprocity. Informal knowhow trading possesses a lower transaction cost than more formal agreements to license or to sell. Often the high cost of research and product development and the rapid pace of product obsolescence (shortened product life cycle) have compelled enterprises to co-operate in research and development while they compete in production, marketing, and servicing of their product variants (Gray (1983)). The fierce and rapid expansion of internationalised competition has made two factors vital for enterprise survival : (1) Flexible and quick reaction to changing market conditions. (2) Positioning of enterprises ("strategic partnering") in such a manner that they themselves compete to influence the functioning of future markets (Mytelka (1987)). This dual concern of multinational enterprises has promoted the rate of technological change, obliging enterprises to engage in new growth and internationalisation strategies that reduce costs and enhance the flexibility of knowledge production throughout their networks. The reduction of marketing risks and uncertainty involved in the generation of new product variants and processes parallel to the penetration of new geographical markets has arbitrated transactional linkages which, by incorporating rivals in a highly technologically based market structure, offer a network value-added premium. What are the two driving forces behind these stylised facts? As the affiliates of MNEs increase their degree of integration in world-wide or regional networks, the degree of effective competition may also rise. Commonly, economists have viewed competition as a type of zero sum game, i.e. "win-lose situations" expressed in the distribution of market shares. Co-operation at various levels of the value chain may be viewed on the other hand as positive sum game situations, i.e. they often represent "win-win situations". Originally, the economic incentive for enterprises to go multinational may simply be to take advantage of differences in factor prices by utilising afirm-specificintangible asset in a foreign country (Helpman and Krugman (1985)). However, enterprises have a further economic incentive to expand beyond the point of factor price equalization. The flexibility achieved by network membership suggests that

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the advantages of multinationality itself may be greater than expected from traditional trade theory. Even if factor prices are equal, incentives based upon co-operative competition and knowledge creation make further use of firmspecific operational and functional complementarities economically feasible. Economically, a multinational network is characterised by a string of options denned by institutional barriers, which determine its value. From the enterprise's point of view, the flexibility to transfer resources across geographical boundaries is a positive contribution to its earning system. Institutional arbitrage as expressed through new forms of internationalisation provides a valuable hedge against contingent events (Gilroy (1989b), (1993)). Inter-enterprise co-operative agreements in complementary knowledge production activities (through networking) function as a means of minimising the costs, risks and uncertainties associated with technology-based modes of production (exchanges of information). Enterprises desiring to increase their working technological base, thereby increasing theirflexibility,may seek to appropriate new skills and capacities through subcontracting, linkages between universities, research institutes and firms and inter-enterprise agreements in research and development, production and marketing. Effective competition depends increasingly upon effective collaboration strategies. This results in an added strategic enterprise value and knowledge creation giving a competitive edge (compare Figure 5.4).

r

i

r—l

KnnwlprJnp

>

Internalization

1

EnvircDnmental KnowPledge

Knowledge Creation

Knowledge Distribution

< " \ Knowledge Externalization

Fig. 5.4. MNE Networks as Organisational Knowledge and Learning Systems As recently pointed out by Teece (1998, p. 58), knowledge sharing itself can often be the basis of competitive advantage:

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B. M. GILROY "In this century, developed economies have undergone a transformation from largely raw material processing and manufacturing activities to the processing of information and the development, application, and transfer of new knowledge. As a consequence, diminishing returns activities have been replaced by activities characterized by increasing returns. The phenomena of increasing returns is usually paramount in knowledge-based industries. With increasing returns, that which is ahead tends to stay ahead. Mechanisms of positive feedback reinforce the winners and challenge the losers."

Several factors are responsible for the increasing returns phenomena and the insight that economic prosperity and modern economic growth is founded upon knowledge and its useful application. Arrow (1962) was among one of the first economists to point out the idea that learning and experience lead to never-ending improvements of capital. Non-rivalry of knowledge capital may prevent returns to capital to diminish. Given that returns to input are constant, an economy can (theoretically) expand indefinitely (compare further e.g. Romer (1986), Romer (1989), Romer (1990), Romer (1993), Lucas (1988), Grossman and Helpman (1991), Teece (1998), Nonaka and Takeuchi (1995), Dunning (2000), Pohlenz (2000)). Relevant factors such as entrepreneurship, standards and network externalities, customer lock-in, large up-front costs, and producer learning based upon the economics of increasing returns have generated new enterprise strategies in which getting the timing right and being well positioned all add to the dynamic capabilities of enterprises. Teece (1998, p. 62) goes as far as to suggest that "indeed, the competitive advantage of firms in today's economy stems not from market position, but from difficult to replicate knowledge assets and the manner in which they are deployed." Networking represents largely sequential flows of information stemming from the advantages of flexibility inherent in a multinational network system. In the uncertain environment of international markets, production flexibility is achieved by the ability to change a process from one mode of operation to another. One of the most significant benefits of such flexibility is to provide the manufacturing process with an ability to modify itself in the face of uncertainty (Kulatilaka and Marks (1988), Casson (2000b)). As suggested by Figure 5.5, sustainable competitive advantage depends on the dynamic capabilities of an enterprise. The enterprise is a repository for knowledge. If one accepts that the essence of an enterprise is its ability to create, transfer, assemble, integrate, and exploit knowledge assets, the entrepreneurial rather than the administrative side of corporate governance is focused upon. Boundary issues (such as vertical integration) are not solely determined by transaction costs. Rather, they are strongly influenced by tacit knowledge and imitability/replicability considerations. Competitive advantage becomes not only a matter of ownership of knowledge assets and other assets complemen-

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tary to them, but also to the ability to combine knowledge assets with other assets to create value. Exploitation of knowledge assets shifts the focus of attention from cost minimization to value maximization (see Teece (1998), Gilroy (1993, pp. 111-124)). According to recent patent statistics, the 700 largest industrial companies most of them MNEs - account for half of all commercial innovations (Cantwell (1996), pp. 145-180). Cohen and Levinthal (1989) and Burger (1999, p. 118) further emphasizes the fact that the "spillover efficiency of MNE technology transfer" requires that one takes account of the "double function" of research and development (R & D) activities of firms. R & D activities of enterprises are simultaneously essential for innovative as well as imitative activities. Local enterprises that do not invest in learning cannot expect spillovers to have a significant effect on their level of efficiency. Training externalities, they point out, do not work when the absorptive capacity in the local firm is insufficient. Local companies, however, that do invest in training obtain additional learning economies over time (learning to learn effects), i.e. they achieve comparative advantages in external knowledge exploitation capabilities. One of the central prerequisites for endogenous regional development is the ability of the region, to adapt their economic and social structures and potentials to changing external challenges (Thierstein and Langenegger (1994)). Additional economic "rents" (superior profits) are most likely to be achieved through the exploitation and deployment of know-how facilities and valueenhancing productivity increases of knowledge workers. This may lead to a dynamic industrialisation and competitive sustainability process as suggested in Figure 5.6 where local companies themselves act as spillover senders because they are more experienced in adapting external knowledge to local conditions (Burger (1999, pp. 65 con't.)). Additionally, increases in education and training levels will eventually translate into higher consumer spending and growth effects. It is not only a question of MNEs bringing their advanced technology to the location. Another precondition for a potential technology/knowledge spillover requires that receivers invest in technological learning or in their absorptive capacity. Basically, it is the creation of an innovative-imitative environment which is desirable since given that firm-specific know-how is mobile, which definitely applies to the case of unembodied technology, " . . . then know-how is not only the knowledge concentrated in one location but the whole stock of intrafirm know-how worldwide (Burger, (1999), p. 121)." Ozawa (2000, p. 218) has termed such knowledge transfer effects accordingly as the "markethitchhiking" effect of trade and investment of MNEs. Thus, MNEs can bring in new "created assets" such as technology and skills which potentially result in external economies of concatenation which enhances the catching-up processes and serve as powerful driving forces for economic development and structural accommodation and social upgrading processes. Since countries are

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B. M. GILROY Complementary Assets & Technologies

Dynamic Capabilites*

Inherent replicability of the product

Standards

Intellectual poperty protection afforded the product Basic (operational) competences of the firm

Price/Performance characteristics of the product

* Dynamic Capabilities are the capacity to sense opportunities, and to reconfigure knowledge assets, competences, and complementary assets and techologies to achieve sustainable competitive

Source: Teece (1998), p. 73 Fig. 5.5. Capturing Value from Knowledge Assets characterised by different levels of industrial advancement MNEs act as vital catalysts for structural evolution. "Both leaders ("lead geese") and emulators ("follower geese") can mutually benefit from interactions with each other in terms of trade and investment opportunities (Ozawa (2000), p. 217)." Over three-fourths of the South African labour population (ages 16-65) is black African, with 8 percent coloured, 3 percent Indian, and 14 percent white. Rates of labour force participation range from 52 percent for Africans, 72 percent for coloureds, 79 percent for Indians, and 85 percent for whites. The unemployment rate is 14.5 percent for African men, 12.3 percent for coloured men, and 2.8 percent for white men. Women exhibit a similar pattern of labour force participation: 62 percent for whites, 39 percent for Indians, 56 percent for coloureds, and 32 percent for Africans. 18 percent of the black and coloured women are unemployed, 9 percent of Indians, and 4 percent of whites (Mwabu and Schultz (2000)).

5 CHANGING VIEW OF MULTINATIONAL ENTERPRISES

Multinationals enterprise Headquarters

f J 'V

Transfer of R&D and learning results

119

Local Company

Subsidiary

\ V /""

Rise in knowledge capital in form of

Rise in knowledge capital concerning

Ownership advantage * Internalisation advantage

-

Direct Transfer

Production and import technology Use of technology Exchange of technology

Indirect Transfer

Source: Burger (1999), p. 119 Fig. 5.6. Knowledge Spillovers

With regard to South Africa, a recent study by Mwabu and Schultz (2000) has estimated that wage rates of whites to be roughly five times as large as those for Africans, three times the wages of coloureds, and twice those of Indian workers. They concluded that some 50 percent of these unusually large differences are founded in years of education of nonwhite compared with white groups. Primary school educational attainment of Africans of labour force age is around 7 years for both men and women. Among coloured persons education is about 8.6 years for men and 8.2 for women. Indian men attain 10.6 years of schooling and Indian women 9.3 years. White men generally receive 11.8 years and 10.4 years for women. Their research further indicates that wage returns to education increase with the level of education and decrease with the average educational attainment of the race and sex group. They conclude that private and social priorities should favour increasing the supply of secondary and higher educated workers in South Africa. They have estimated that wage returns to Africans for a year of secondary education are nearly twice as large as the corresponding returns for whites, 16 percent versus 8 percent for men and 25 percent versus 5 percent for women, respectively. These numbers go along with the observation that in the 1960s, five times the public resources were spent on a year of white secondary education as on African secondary education. In 1990, the differential was two to one.

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In this sense, tertiary education will indeed be crucial for the South African economy. According to Randall (1994, p. 164), in 1993 one-third of 1.8 million managerial and professional posts were unfilled owing to a skill shortage. Related to this shortage of higher level personnel is the high failure rate of black students at both school and university levels of education. Behrens and Rimscha (1994, p. 183) estimated that during the period 1998-2000 the South African economy was looking for some 225,000 university graduates more than it could find. The policy of "black empowerment" requires employees to occupy jobs with blacks to try to break down racial asymmetries. Some observers go as far as to argue that instead of de-racialising, the government is re-racialising. Even though the majority of the South African population is black, whites occupy 95 percent of management positions in the economy. Better-educated whites and blacks are, however, now emigrating from South Africa as they perceive their perspectives to be better elsewhere. Doctors, lawyers, computer specialists, teachers, etc. are becoming scarce (FAZ (2001), Lohse and Barkemeyer (2000, p.81)). Mwabu and Schultz (2000) also found that access to the transportation system that links nonwhite residential communities to the higher wage urban labour markets and vocational training programs also is reflected in African men and coloured workers receiving markedly higher wages. In the scope of the Reconstruction and Development Programme (RDP/see ANC (1994)), even though various delays have occurred, several educational reforms and targets have been implemented and important progress has been made. The importance of social and private human capital for the South African government has been underlined by the increasing expenditure on education every year since 1994. There still remains, however, much to be accomplished. As pointed out by Drucker (1999), the most important contribution of enterprise management in the 20* h century was to increase manual worker productivity fifty-fold. The most significant contribution of enterprise management in the 21s t century will be to increase knowledge worker productivity - with a bit of luck by the same percentage. As he points out, productivity of knowledge work has to aim at achieving maximum quality. Quality is the essence of the output, which must be motivated to grow (Drucker (1999), p. 87): "In no other area is the difference greater than between manual-worker productivity and knowledge-worker productivity than in their respective economics. Economic theory and most business practices sees manual workers as a cost. To be productive, knowledge workers must be considered a capital asset. Costs need to be controlled and reduced. Assets need to be made to grow." In the final instance quality may be interpreted to mean maximizing organizational behavior which permits both manual and knowledge workers within enterprise network systems to enhance the satisfaction of present and poten-

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tial customers by establishing systematic learning relationships (compare e.g. Cole (1998)). Basically, MNE network systems may normally be viewed as collective problem-solving institutions serving as an engine for growth, change and innovation. In spite of this, a caveat put forward by Mark Casson (2000a, Chapter 7) is in order. Examining the literature from such various academic fields as politics, economics and economic history, sociology and geography one must further scrutinize a typology of networks. As he points out, there are "good" networks and "bad" networks as far as regional development is concerned. Good networking, he argues, is typically open, transparent and entrepreneurial, and involves the provision of "public goods" to industry. Bad networking is typically closed and opaque often resulting in "rent-seeking lobbying" in which enterprises, entrepreneurs and politicians combine their joint efforts to shield and protect weak regional industries against external competition. Rugman, Kirton and Soloway (1999) illustrate vividly such negative aspects of enterprises and governments aggressively seeking strategies within the trade-environment conflict and North American Free Trade Agreement (NAFTA) to keep open access to international markets, while maintaining shelter at home. A formal theory of multinational networks is still non-existent. As pointed out by Williamson (1991, p. 13), economists have neglected study of organisational efficiency in part because the mathematics for dealing with "clusters of attributes" is only now beginning to be applied (e.g. Topkis (1978), Milgrom and Roberts (1990)). Teece (1980, 225) and Langlois (1989) have emphasized that conclusions regarding the appropriate boundaries of an enterprise cannot be derived by simply studying the nature of the underlying cost structure. The cost function (which is simply the dual of the production function) summarises all economically relevant information about the production technology of the enterprise. The traditional usage of the cost function does not, however, summarise the enterprise's organisational technology. Changes are taking place on the boundaries of enterprises rather than at their core, where traditional business economists have commonly concentrated their analysis. An enterprise competing internationally must decide how to spread activities in the spatial value chain among different countries. Co-ordination among interdependent enterprises requires the establishment of exchange relationships at an economic cost. A recent important organisational cost reduction tendency can be observed concerning the choice between transactional modes. On the basis of employing networks to get the job done faster, time has become one of the main sources of enterprise comparative advantage (Stalk (1988)). The search for new competitive approaches in multinational enterprise is producing new organisational forms culminating in international dynamic integrated networks. These new structures are both a cause and a result of today's

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global market environments in which enterprises compete to combine strategy, structure, and management processes most effectively. Relative disparities of enterprise capabilities and their respective gains are transforming the nature of multinational enterprise collaborations. In earlier times contractual forms of internationalisation were to a large degree ad hoc. More recently, as the input factor time has begun to play a more significant role due to life cycle and technology gap aspects, enterprises are increasingly seeking to hedge against the risk of defection by establishing more stable partnerships ("strategic alliances") within long-term global networks diversified over a vast series of projects (Tucker (1991), p. 119). Based upon the evolutionary process of technological development and structural changes in international markets (compare e.g. Schmidt (1996)), strategic alliances are often predestined to be inherently unstable. In judging the success or non-success of strategic partnerships it is necessary to take into account the positional payoff - that is, any additional competitiveness derived for the involved parties that arose out of the collaborative venture. Since it is only natural that the complementary firm-specific advantages of the involved parties change over time, so will the organisational and competitive positional fit of strategic alliances change enterprise boundaries over time, depending upon the learning curve effects that occur in playing the iterated game in the merry-go-round of strategic alliances. Preliminary evidence as well as economic theorising suggest that intensified levels of interand intrafirm co-operation will no longer be the exception but the rule. Rivalry among MNEs (compare further Brenner (1990)) will, however, remain very intense "since strategic alliances have something of the flavour of tennis doubles partnerships where each player is free to pursue a single career" (O'Brien and Tullis (1989), p. 13).

5.4 EVALUATING THE IMPACT OF INTEGRATION AND THE MULTINATIONAL ENTERPRISE ON AFRICA During 1987-1996, global trade - as measured by total exports - increased by $2.9 trillion in absolute terms, or by an average annual rate of 9.3 percent. This was more than three times the rate of increase for the global GDP. Presently, there exist world-wide some 33 active regional trade agreements with a total of 358 countries (Fatemi (2000, p. 4 and pp.10-11 for a detailed listing of regional agreements)). The implication being that on average, each nation around the world participates in more than two regional trading blocks. All else equal, goods from another member country joining a trade block should reduce its levels of imports from non-members, an effect called trade diversion. In examining the question, for example, whether regional trade blocks have diverted U.S. exports, Wall (2001) has found that the Association of South

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East Asian Nations Free Trade Area (AFTA) has had not much of an effect on U.S. exports; the formation of the Andean Community may have led to a decrease in U.S. exports; and Mercosur may have even resulted in an increase in U.S. exports. What do we commonly mean when we talk about economic integration? In economic terminology, the term is generally applied to denote a state of affairs or process which involves the amalgamation of individual economies into larger regions. Viewed as a process, integration takes in methods intended to abolish discrimination between nations. Perceived as a state of affairs, integration embodies the absence of a range of discrimination methods between national economies. Through integration the participating economic units desire to obtain economic (and political) co-ordination, economic (and political) co-operation, and enhanced efficiency in the allocation of scare global resources. On a macroeconomic level, integration often serves as an arbitrating process much in the sense as trade is viewed upon as the mechanism, which tends to equalise factor prices internationally. Additionally, the perspective persists that foreign direct investment flows are based upon international capital arbitrage that has the tendency to equalise interest rates internationally. On a more microeconomic level integration involves obtaining the benefits of economies of large scale production as the market size increases stressing differences in the qualities of factors of production as technological processes are arbitrated internationally. Africa has been experimenting with economic integration for half a century, with at least eleven economic blocks in quest of economic prosperity. Some of these efforts are: the Economic Community of Western African States (ECOWAS); the Common Market for Eastern and Southern Africa (COMESA); the Economic Community of Central African States (CEEAC); the Southern African Development Community (SADC); the Arab Maghreb Union (AMU); the Economic Community of the Great Lakes Countries; the Mano River Union; the EAC. Although not especially economically successful (due to a variety of reasons), the regional alliances are important in the sense of promoting the spirit of free trade and investments as well as gathering experience on the regional level that hopefully will translate into improved governmental and private investor competence at the global level. Globally, African nations desire improved access to American and European markets (especially for farm and textile products). Correspondingly, America and Europe wish to open service markets and protect intellectual property. Accepting the fact that most African nations are too small to effectively bargain single-handedly with America or Europe, they have attempted to build integration alliances (The Economist (2001d)).

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Characteristic of all attempts at economic integration is the removal of trade barriers among members. Discrimination against the "rest of the world" remains, which may be detrimental to global production or even enhance FDI along the lines of the "tariff-jumping argument" of FDI investment strategies (Broil and Gilroy (1994), p. 140-143). With regard to "local content" legislation of governments, Lopez-de-Silanes, Markusen, and Rutherford (1996) have also demonstrated how such discriminatory restrictions may generate anti-competitive and rent-shifting effects when the industry in question is oligopolistic in nature. They find that enterprises unaffected by the content restriction are helped to the extent that their rivals are hurt, an effect of no particular significance in traditional competitive trade models. The anticompetitive effect tends to worsen welfare within the trade block while the rent-shifting effect tends to improve welfare, to the extent that the favoured enterprises are owned within the block. Conceivable is even a situation in which the content restriction rules reduces the equilibrium output of the substitute domestic intermediate inputs, and thereby fails to protect an industry it is suppose to help. International and regional trade agreements tend also to promote investors to look for preferential market access. Accordingly, the increasing impact of FDI on trade flows is one of the new issues. There is a growing inseparability of trade and investment decisions of MNEs. A further emerging issue is the choice of entry mode in FDI. Entry through FDI can either occur through acquisitions of existing firms or through "Greenfield investment", i.e. setting up a new subsidiary. Greenfield investments tend to be more integrated with the parent company than acquired firms (Svensson (1998)). It has been noted in the literature that larger intra-firm trade volumes between parent enterprises and greenfield affiliates, often indicate that transfers of embodied technology play a significant role when the chosen entry mode is a new subsidiary (Anderson et.al. (1996), Caves (1996), Svensson (1998)). Further, many developing countries use FDI as one among several avenues to integrate their economies into global production chains. The question emerges whether or not such incoming FDI serves to stimulate the host economy and to enhance its competitiveness in world markets. Opponents argue that FDI is isolated in enclaves and that where it does develop local linkages, these are commonly in the form of ruinous competition among would-be suppliers. The basic criticism is that MNEs are insufficiently concerned about national societal interests as they emphasize their global operation strategies. The sheer size of many MNEs puts them in a preferred bargaining position with governments and government officials. The sales of GM, Exxon, or Mitsubishi, for example, are greater than the GNP of such medium-sized economies as Argentina, Indonesia, Poland and South Africa. This offers them considerable bargaining power in negotiating business arrangements, which commonly have repercussions in many geographical locations, among governments. Proponents of FDI suggest the prospective gen-

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eration of backward and forward linkages between affiliates and local firms resulting in transfers of technology to the local economy and an upgrading of local workplace skills. In general, however, the findings are mixed and dependent upon the specific case at hand (see e.g. UNCTAD Press Release, 19 December 2000). Further, the effects of MNEs activities may at the same time be positive for one national objective and negative for another due to the trade-offs among objectives given. For example, employment effects are viewed as being positive, whereas the increasing spheres of MNEs influence on domestic control of economic matters is usually regarded to be negative. Most importantly, however, it is the host economy that shapes the effects MNEs have in their environments. Both parties may benefit given that reciprocity norms of collaborative arrangements evolve and are promoted, as well as agreements achieved concerning the distribution of potential benefits (compare e.g. Markusen and Melvin (1984), Broil and Gilroy (1986)). Outward-looking trade and investment policies commonly open up new opportunities for competitive development. Koizumi and Kopecky (1980) have, for example, illustrated that far from being detrimental to domestic workers, MNEs tend to improve domestic employment opportunities over the long run due to learning-by-doing effects of technology transfers through transfers of managerial expertise. Given that governments and private citizens invest in improving local skills, institutions and supplier capabilities, they gain far more from the presence of foreign subsidiaries of MNEs (see Section 3 above). As remarked by Daniels and Radebaugh (1998, p. 443) the situation is in accordance with an old Chinese proverb: "If a little money does not go out, great money will not come in." Without going into detail due to space restrictions, most of the literature now accepts the fact that the inflow of FDI through MNEs increases local development and utilisation or upgrading of resources (compare Dunning (1993/1996), Caves (1996)). Many of the arguments found are based upon the insight that both home and host countries may gain from FDI when resources are not inevitably fully employed which leads to an industry-specific and complementary nature of capital and technology. Of course, there exists much controversial evidence of MNEs being linked to inequitable income and power distribution, environmental debasement, and societal deprivation. Although many such instances are indeed quite spectacular or extreme in nature, they usually represent isolated examples and should not immediately be postulated to be the typical case of MNE behaviour. Keeping this caveat in mind, one generally observes however, that the above five transmission channels have been positively and extensively discussed in the literature throughout the years.

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MN Es

Inves tment

Huma n Resoiirees

Technology

- Linkatjes to Local Companies

- Training

-R&D

- Employment

- Industr al Upgrac ing

- Increa sed Productivity

- Manac erlal Skills "

- Improved Efficie ncy

- Learn ing Effects

-NewC apital Equiprr ent

Tra de

Enviro nment

- Export Expans ion

- Access to clean Techno ogies

- Lower- cost Imports

- Pollutic nAbaterr ent Skills - Company-wide Standa rds

- Capiteil Forme tion

Source: Adapted from Transnational Corporations and Management Division. World Investment Report 1992: Transnational Corporations: Engines of Growth, An Executive Summary, (New York: United Nations, 1992), p. 13. Cited from Daniels and Radebaugh (1998), p. 452.

Fig. 5.7. Resources and Contributions of MNEs The ongoing discussion on the consequences of the rising integration of the developing countries in international trade and investment flows is of increasing importance to world network structures. These developments may be interpreted in light of a common technological base for the nations involved (Broil and Gilroy (1988)), or it may simply be that different production stages are integrated through the use of regional resources and market complementarities, thus offering a significant infrastructural element for subsequent trade, investment and technological flows among nations (Monkiewicz (1985)). In any case, the process of economic development is to a large extent contingent upon the cumulative effects of appropriation and development of technological advancement in which MNEs play a central role (Gilroy (1993), pp. 163-18). However, as Lall (1990, p. 16) has commented, "the development of national technological capability is subject to a large, diffuse set of influences, and there does not exist a corpus of economic theory that allows us to specify the

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precise chain of causation and attribute the contribution of different variables influencing it."

5.5 AFRICA, AIDS AND MULTINATIONAL ENTERPRISES This section offers a brief, however, important digression necessary in understanding how the shadow of the AIDS epidemic is affecting the behaviour of multinational enterprises in Africa. HIV Prevalence

Estimated AIDS

(Percent of Population age 15-49)

Deaths

Demand for AIDS Health Services' (Percent of GDP)

Health Expenditure 1994-98

(Percent of GDP)

Botswana 01. Aug 35.8 24 2.0 Lesotho 23. Jun 16 0.9 04. Aug Malawi 16.0 70 0.8 & Mozambique 13. Feb 98 0.6 1.0 01. Mrz Nambia 19. Mai 18 03. Aug South Africa 19. Sep 250 0.7 3.0 02. Mrz Swaziland 25. Mrz 0.9 7,1 Zambia 20.0 01. Mrz 02. Aug 99 160 01. Jun Zimbabwe 25. Jan 02. Feb Sources: UNA DS, Report on the Global HI V/AIDS Epidem ic (Geneva:UNAIDS, 2000); and IMF staff estimates. Cited according to IMF (2()00), p. 38. 1 Estimated cost of treating alL\IDS patients a local standards . In practice, costs may be reducec by rationing.

Table 5.3. The Economic Impact of AIDS in Southern Africa (1999, unless otherwise noted) Approximately 47 million people are estimated to be infected with HIV/AIDS world-wide since the epidemic started two decades ago. Some 34 million infected are in sub-Saharan Africa. Africa has roughly 12 percent of the world's population, yet accounts for 80 percent of the world's deaths due to AIDS (UNAIDS, December (1998)). With almost 90 percent of the world's deaths due to malaria, the World Health Organization has further estimated economic losses due to Malaria alone at $2.2 billion a year, and said malaria deaths could be reduced by half the amount at an estimated cost of $ 1 billion annually ( www.africapolicy.org ). The World Health Report (1999) observes that the economic burden of malaria to African countries in general is at

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least one percent of gross domestic product (GDP). As illustrated in Table 5.3 above, The Joint United Nations Program on HIV/AIDS (UNAIDS) estimates that about 36 percent of the adult population in Botswana, 25 percent in Zimbawe and Swaziland, and 20 percent in South Africa and Zambia are infected; this compares to a prevalence rate of 8.6 percent for sub-Saharan Africa and 1.1 percent for the world as a whole (IMF (2000), p. 37). Due to the long incubation period the social and potential macroeconomic impact of the HIV/AIDS pandemic will be extremely severe and its full effects are yet to be felt. There will be substantial effects on a broad range of economic variables such as GDP growth, poverty and income inequality, labour supply, domestic saving, productivity, and human, physical, and social capital. The initial impact of AIDS is expected to be felt in the public sector, as health care expenditures increase and tax revenue bases erode due to the adverse effects of illness. The quality of the public services will most probably deteriorate as qualified employees are lost and can not be rapidly replaced. Health is an indispensible component of development, productivity and growth. The costs of absenteeism will be significant and the impact on public sector pension funds substantial. During the mid-1990s, African countries were paying more than $25 billion a year to service their debts, and only about $15 billion a year on health (http://www.africapolicy.org). The shadow of AIDS affects almost every facet of daily life in South Africa. South Africa has more Human Immunodeficiency Virus (HlV)-positive people than any other country in the world. The South African Ministry of Health suggests that some 2.5 million inhabitants are HIV-positive, whereas the UNAIDS (the United Nations AIDS body) estimates some 4.2 million people infected - approximately one-tenth of the total population. Although many of the problems involved with the economics of AIDS are only starting to surface in South African society, optimistic estimates are forecasting some four million deaths in South Africa within the next ten years due to AIDS. The more pessimistic forecasts say that as many as six million deaths are to be expected by the year 2010, when the epidemic is expected to reach its peak. Average life expectancy is set to fall from 60 years to 40 by 2008. The number of deaths due to AIDS and the potential vast increase in the number of orphans (an estimated two million by the year 2010) will put enormous strains on the South African society. In Botswana, for example, orphan allowances have been estimated to most probably exceed 1 percent of GDP by 2010 (IMF (2000), p.38). The effects of AIDS is especially affecting the social structures of local communities by disrupting existing social networks and traditional support mechanisms (IMF (2000), p. 37). Annually some estimated 120,000 to 250,000 South Africans die of AIDS. In year 2010, if the estimates are correct about 600,000 South Africans will die of AIDS. This corresponds to

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some 1,650 deaths daily, which also correspohds roughly to the number of inhabitants that newly infect themselves daily (Bundesstelle für Außenhandelsinformation (bfai) (1999a ,b). During the year 2000, official figures released on March 20*ft, 2001 stated that a quarter of a million South Africans died of AIDS and the epidemic appears to be on the rise. According to the statistics, approximately 4.7 million South Africans - one in nine - now carries the HIV which causes AIDS. This is 12 percent more than in 1999. The latest survey of tests performed on expectant mothers found that 24.5 percent of women so tested were HlV-positive, up from 22.4 percent in 1999. In KwaZulu-Natal, the worst-affected province, 36 percent of pregnant women tested positive (The Economist, (2001c), p. 53). By 2015, South Africa's population is expected to be 23 percent smaller than it would have been without AIDS (The Economist (2001b), p.75). Primarily due to the impact of the HIV/AIDS pandemic, life expectancies for Africans have dropped drastically. Only 9 out of the 53 African countries for which the World Health Organisation (WHO) registers data have life expectancies of 50 years and over, as compared to 130 of the 138 countries outside of Africa. Among the 52 countries with life expectancies less than 50 years, 44 are African and only 8 are outside Africa (WHO (2000)). 30

20 •

15 10

*

5 0 1980

,».,..%••«•:•;¥:¥ T

1983

T

f

1986

I

f

1

1989

1992

1995

1998

2001

Source: N.A.(2002). Fig. 5.8. HIV and AIDS Roughly estimating the yearly costs of treating a HIV patient to be currently about $10,000, the demands on the health-care system in South Africa will be horrendous. As illustrated above, the public-sector health bill will increase from some 28 billion rand this year to an estimated 38 billion rand in the year 2010.

130

B. M. GILROY % Expenditure on liealth

Guinea-Bissau* Ljbyan Arab JamaWriya Central African Republic* Burundi

Erilrea Somalla Nigeria Botswana Djibouti Cote d'Ivoire Angola Gabon Tunisia Mauritiiis Sierra Leone* Llberia

Equatoria] Guinea

SouthAMca Algeria

Senegal*

Source: World Health Care Report, (2001).

Fig. 5.9. Public-Sector Health Care Costs

Sectors of the South African economy will be affected to different degrees. Estimates of the United Nations suggest that the AIDS epidemic will lower the growth rate generally by 0.3-0.4 percent each year, making South Africa's GDP in 2010 seventeen percent (or $22 billion) lower than it would have been otherwise. Not only the public sector will be affected by HIV/AIDS. The private sector will also be affected through lower productivity and costs related to labour turnover, a shrinking labour supply, and medical, pension,

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and death-related benefits. By and large, AIDS-related costs equivalent to 50100 percent of an infected employee's salary appears realistic. Some studies have even suggested for each HIV infected employee of a South African firm approximately twice the infected worker's salary (The Economist (2001b)). A study conducted by Metropolitan Life for the manufacturing sector in South Africa suggests that, based upon HIV/AIDS, at the company level the costs of death-related benefits across all employees will more than double between 1997 and 2007 (from 5.5 percent to 12 percent of total payroll) (IMF (2000), p. 38). AIDS will also have a substantial impact on the general supply of labour and human capital. Some evidence suggests that children of AIDS victims often drop out of school to care for their sick relatives or because schooling is no longer affordable for the family. Naturally, this will have a major affect on the supply of human capital in the long run. Investment and physical capital may well decrease due to HIV/AIDS, as domestic saving falls unless an increase in foreign aid offsets the likely decrease in foreign direct investment (FDI). Precautionary saving might increase, on the other hand, with households taking into account the enhanced risks of contracting AIDS-related diseases. Poverty and income inequality will likely rise as economic and social relationships become increasingly disrupted and the adverse impact on internal and external confidence may promote the danger of macroeconomic instability as the fiscal position deteriorates (IMF (2000), p.39, Cuddington and Hancock (1995)). Approximately $300 million dollars are currently being spent globally on research for a vaccine against HIV, representing roughly a tenth of the sum spent on purchasing drugs to treat the disease in America and Europe where anti-retroviral drugs have turned AIDS in the West from a disease that causes imminent death into one that is merely incurable. As mentioned above, worldwide some 47 million patients are infected with HIV. At first glance, one might contend this represents a highly lucrative market for the big four major vaccines developing pharmaceutical multinational enterprises such as Aventis, Merck, GlaxoSmithKlein and American Home Products. Since 1987, 30 potential AIDS vaccines have already been clinically tested on more than 6,000 volunteers, mainly in America and Thailand. However, the commitment of the large drug companies has often been hesitant. The basic problem is that a large majority of HIV infected patients live in Africa and do not command enough money necessary for sufficient treatment (The Economist (2001e). From the perspective of the pharmaceutical MNEs an additional problem is also one of "patent infringement" through the importation or production of low cost generic substitute drugs. Declarations known as "soft law" threatened the value of their patents. Two mechanisms endangered the industry's price-setting power. First, the "compulsory license", which would give a government legal power to permit manufacture of a drug without the patent-holder's consent while paying "reasonable roy-

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2,500 2,000 1,500 1,000 500

•~, r T 1 1 ! I

0 1980

1983

1986

1989

1992

1995

1998

2001

Source: UNAIDS, 2002 Fig. 5.10. Death Toll of HIV/AIDS alties". Secondly, the so-called "parallel importing" in which a country purchases products at lower cost in another market and resells them, without the manufacturer's permission, at home. Confer further the informative documentation given by a recent seven-part series of articles on AIDS, Drugs and Africa appearing in the Washington Post (December 27, 28 and 29) (2000) (http://www.washingtonpost.com/wp-dyn/world/issues/aidsinafrica) and by the international medical aid agency Medecins Sans Frontieres (MSF)(2000) (http://www.accessmed-msf.org ). The most recent development (see e.g. Grill (2001)) was that 39 pharmaceutical MNEs belonging to the Pharmaceutical Manufacturers' Association (as representatives of the rich North) wishing to protect free trade and patent right profits started a legal battle with the government of South Africa (representative of the developing countries) who calls upon their constitutional right of law to "Life" and the new Medicines Control Amendment Act No. 90 which demands access to affordable drugs. The case was withdrawn on 18th April 2001. Observers of the situation have been talking of "global apartheid in health services". Brazil was the first country to distribute self-made copies of AIDS drugs from the North without cost to the infected and managed to reduce their death rate by 50 percent. South Africa is now also commencing parallel importing of AIDS medicines from the Indian enterprise Cipla. The moral pressure on the pharmaceutical companies from the North is increasing as evident from Merck's most recent offer to supply the needed anti-AIDS medicine for $500 to $600 a year. The political waves of such actions are only beginning to roll as South Africa has landed on the Watchlist 301 and the U.S. apparently even considered reducing their development aid support by some $30 million.

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There is also a negative side to the effects of free drug treatment such that improper usage may paradoxically lead to the HIV becoming rapidly resistant and spreading even more quickly. The pharmaceutical industry spends approximately 25 billion dollars yearly on research and development; only roughly one-tenth of this sum is however, applied to researching common diseases in poor countries such as malaria and tuberculosis among others. 780 million Africans - some 13 percent of the world population - purchase only one percent of the world's production of medicines (Grill (2001)). In 1996, the AIDS Vaccine Initiative (IAVI) was founded and headed by Seth Berkley. This organisation is pushing forth new partnerships and network ties between industry, charity and governments to research and develop new AIDS vaccines and get them quickly to the clinical test phase. Recently, the Gates Foundation (indirectly a charity spin off of the software multinational Microsoft) has granted an additional $100 million donation to earlier contributions to IAVI. The Biotechnology Company Alphavax in Durham, North Carolina was originally funded with money from IAVI and is now planning along with its partners in South Africa to start human safety trials of its new vaccine (The Economist (2001e)). Although South Africa is statistically considered a middle-income country according to international standards most South Africans are poor. Despite the government's effort since the end of apartheid, the general situation will realistically take time to be improved upon. It is difficult to get well established data on the situation, however, in 1996 some 57 percent of the South African population have been estimated to be living in poverty with lack of housing, water, land and other essentials of life. The current government has attempted to supply the bare necessities of life and the current day situation of many South Africans has indeed been improved upon. Black household incomes have risen by 9 percent in real terms over the last five years. Further, the government argues that since 1994, some additional nine million people now have access to clean water and about 1.5 million additional households now have electricity. Attempting to insure a daily nutritional calorie intake, the government has implemented a free peanut-butter sandwich a day program for all children attending primary schools. Furthermore, basic pensions for the elderly poor have also been implemented. There remains, however, much room for further improvement. More than three million households (out of 10.7 million) still do not have access to electrical facilities, and eight million people (out of 43 million) still have no immediate access to clean water.

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However, the income gap between the races has been diminishing over the years in South Africa. Wealth is indeed being redistributed among South Africans. In 1970, whites had seventy-one percent of personal income in South Africa, blacks had twenty percent. By 1990, the white share had decreased to fifty-four percent and the black share increased to thirty-three percent, and the trend is continuing. Further, the richest tenth of the population was ninety-five percent white in 1975. In 1996, it was twenty-two percent. Income and educational levels are also correlated with the occurrence of AIDS. It has been estimated that a quarter of South African miners are HIV-positive, along with roughly a fifth of workers in construction. Industries with bettereducated employees are less affected. For example, less than a tenth of the bank workforce have HIV. In sum then, the total impact of AIDS on society and on the profitability of MNEs is unpredictable, but most probably vast. A typical South African enterprise can expect a fifth of its workforce to die on AIDS. If one is reminded of statements of South Africa's President Thabo Mbeki who questions whether the HIV causes AIDS or his health minister distributing a document last year alleging the virus was created by westerners to kill Africans, then future national AIDS-prevention campaigns will have to be "internalised" by enterprises setting up their own company AIDS-prevention strategies. Various South African enterprises have begun doing just that. For example, among the list of active enterprises are such companies as AngloGold (the largest gold-mining company), South African Breweries (SAB) and Mondi (a papermaker). As noted recently, 24 percent of AngloGold's employees (including office staff) were HIV positive in 1998. 53 percent employed suffered from other sexually transmitted diseases. SAB has not tracked their employees standing for fear that if the information became public consumers would no longer drink their products. Mondi has begun training their staff to perform multiple jobs to fill in when necessary on absenteeism. They have further an extensive programme to keep HIV-positive workers healthy. Other MNEs are pursuing the strategy of hiring as many as three workers for each skilled position, to guarantee that replacements are on hand when needed. Cost-benefit calculations have even been applied such that if an infected worker can be kept alive for three years longer than the average local HIV sufferer, that cost can be reduced by a quarter. The consequence being that it makes economic sense to provide senior managers with costly drugs, of the sort that keep HIV sufferers in richer countries alive. AIDS is also affecting uninfected employees as enterprise health schemes recalculate the basis of their financing. AIDS has increasingly affected even the internal organisation of MNEs as enterprises start to increasingly apply subcontracting and outsourcing strategies instead of permanent staff (The Economist (2001b)).

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Recently, there has apparently been a change in political attitude as hospitals distributed South African imitation medicines ignoring drug patents of the MNEs. This has been pressuring the pharmaceutical MNEs to offer purchasable medicine. The incoherent national AIDS prevention programmes have also been lately improved upon and will hopefully bring the necessary educational effects on future generations improving their health and sustained decline in HIV/AIDS prevalence.

5.6 LAND PROPERTY RIGHTS, GROWTH POTENTIAL AND MICROCREDIT-LENDING The past political system of South Africa erected strong institutional barriers to employment, property rights, civil rights, and regional mobility, discriminating according to an individual's race or ethnic origin. Approximately 46 percent of the South African population live in rural areas, and the remaining 54 percent living in urban areas have strong connections and ties to a village or country community. Despite this relatively urbanised population of South Africa, there are differences across racial and ethnic groups. 93-94 percent coloureds live in urban centers. Effectively all Indian workers live in urban areas, as 91 percent of the whites do. On the other hand, only roughly 32 percent of Africans live in urban areas, with nearly two-thirds residing in the 10 homeland territories (Mwabu and Schultz (2000)). Under apartheid laws, blacks were allowed to own land in the 13 percent of the country located in the "homelands". Approximately 3.5 million black inhabitants were compulsorily removed from their land by the white government between 1960 and 1980 and forced to reside in the homelands (The Economist (1994)). Land aspects are an important aspect of South African society. Historically, owning land was largely denied to blacks, Indians and Coloureds, which represent roughly 70 percent of the population. The white population with its 15 percent had the main access to land. If government-owned land was included, the whites owned 87 percent of the land areas. The question of land ownership is highly emotional, while at the same time being very important for employment and income generation effects. Some 60,000 white farmers own approximately 87 percent of the best land, farming over 102 million hectares. By contrast, approximately 1.2 million black farmers occupy 17mn hectares of overworked and often substandard land (Cargill and Shepard (1994), p. 23). With the abolition in 1991 of the Land Acts South African government is attempting to redistribute some thirty percent (a figure which apparently goes back to a World Bank guess that the government could purchase six percent of white-owned land each year over a five year period) of the country's farmland by 2014. However, of the some 63,000 officially filed applications for

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notarial land transfer or compensation damage claims as few as only 5,000 applications have been processed (Halbach (2000, p. 33)). To date, only 0.81 percent land has been transferred to blacks at the end of the year 2000 (The Economist (1994). This is mainly due to the situation that very few black citizens can afford to buy land on the free market. Highly important for the investment atmosphere will be how Article 25 of the South African constitution, which guarantees property rights legally, is upheld. Land expropriation as illustrated by the case of Zimbabwe (the most important trading partner of South Africa) would be (and is for investment flows to South Africa already) highly detrimental to any investment climate (compare Bundesstelle fur Aussenhandelsinformation (bfai) (1999a,b), Lohse and Barkemeyer (2000)). The importance of land property rights for development and capital accumulation in general has recently been succinctly stated by Hernando De Soto (2000). Property rights taken for granted in industrialised countries are often incomplete or non-existent in industrialising countries. Ill-defined property laws result in dead capital. Landholders can not mortgage what they do not officially own leading to insufficient capital formation. For example, it may be pointed out that the largest source of new startup business capital in the United States comes from entrepreneurs taking out mortgages on their houses. In De Soto's (2000, pp. 6-7) own words, "The poor inhabitants of these nations - five-sixths of humanity - do have things, but they lack the process to represent their property and create capital. They have houses but not titles; crops but not deeds; businesses but not statutes of incorporation. It is the unavailability of these essential representations that explains why people who have adapted every other Western invention have not been able to produce sufficient capital to make their domestic capitalism work." The argument made by De Soto is that if you observe squatters and shantytowns such as Alexandra near Johannesburg, you will find people who live there have created rules about property rights. The trick is making such substantial, informal arrangements formal and readily accessible to a majority. For example, historically the Homestead Act of 1862 once achieved this for the United States. Basically, it gave free title to 160 acres of land if the occupants lived on and developed it. The Homestead Act grew out of the fact that many Americans were already occupying federal lands in violation of federal law. Some economists have, on the other hand argued, that the restitution of land to the blacks may not achieve the desired redistribution effects due to productivity decreases.

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Their argument goes along the lines that if white farms are broken up, and smaller farms imply less productive units, then black farmers who had worked on white farms for wages before the land reform may even earn less income after becoming land owners (The Economist (1994)). As pointed out above in connection with the need for land reforms, the poor often can not borrow from commercial banks because they do not possess collateral such as land and housing. Another element in the discussion on how to get capital accumulation thriving is so-called "microcredit-lending" and "stepped lending". World wide it is estimated that some 14 million people now borrow from micro-lenders instead of from loan sharks demanding 10-20 percent interest rates on a daily basis. Microcredit-lending is being pushed by the Microcredit Summit Campaign (MSC), an active lobbying group. In order to alleviate the immediate effects of poverty, small credit sums of money (a microscopic loan may be as little as $25) are offered to the poor to set up or expand small businesses. Woman are preferred customers, since experience has suggested that males frequently misuse the extra cash on alcohol and other excesses. Often poor borrowers form groups to cross-guarantee each other's loans. When a rural women takes out a microscopic loan to start a "business" (e.g. to buy sewing or weaving material or simply preparing and selling cooked rice to customers), she must first repay the loan before the next village women receives a credit. The mechanism of peer pressure seems to insure that default rates are minimal. Such schemes promote enterprise rather than dependency and may even be self-sustaining. Repayment rates of over 98 percent have been reported. With "stepped lending" a would-be borrower puts up a little money on her own and receives roughly the same amount from the microfinancier. If repayment is promptly made her credit record improves and next time round a larger credit sum can be bargained. The "carrot" of higher credit sums discourages defaulting. Unfortunately, the shadow of AIDS also is increasingly causing borrowers to default. A recent survey of micoborrowers in 14 African countries suggests that 95 percent had trouble paying medical bills. 77 percent had trouble paying for funerals and 50 percent needed the money to look after relatives orphans. Attempts are emerging therefore to even institutionalise combinations of microcredits with micro-health-insurance (The Economist (2001e)).

5.7 CONCLUSIONS Changes are taking place on the boundaries of enterprises rather than their core. Endeavours to modify structures, to adapt processes and to newly define boundaries are due to ongoing integration processes attempting to improve co-ordination and co-operation of separate distinct economic units (be it nations or enterprises) in order to achieve enhanced efficiency through flexible allocation of limited global resources in the face of large risks and uncertain-

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ties. These tendencies have been highly supported by the associated creation and operation of information technology networks that have permitted enterprises to improve communication, control and monitoring of the system. This has enabled them to capitalise on new technologies, thereby improving general productive efficiency (Antonelli (1998)). Although not explicitly discussed above in detail, the fostering of small and medium-sized enterprises is also quite central to this endeavour. The South African Business Development Corporation (SABDC) has estimated that 85 percent of businesses in the country are small, manufacturing enterprises, including the informal sector, and account for as much as three-quarters of all new jobs (Cargill and Shepard (1994), p.22). This also corresponds to the situation in most developed countries. There exists extended empirical observations that "Small firms do not spring up and expand in isolation; rather, they flourish in networks of firms that are part of an integrated cycle of production, with upstream and downstream linkages and a very high level of specialisation in the production of traditional industrial goods" (Mazzonis (1989, p. 63-64)). It is well documented that the impact of economic integration will not be felt equally by all groups in society within a particular country. Two main general issues emerge: (1) the long-term effects of integration and (2) the more short-term oriented adjustment costs of integration, i.e. the costs associated with the process of transition as compared to any final outcome. As Africa becomes increasingly integrated in world markets through the activities of domestic and foreign MNEs, as well as through regional and supranational trade and investment agreements, future long-term research will need to attempt to measure the success or failure of these attempts. It will be necessary to examine more closely the distributional effects of integration. What will be the impact on the factors of production (land, capital, labour)? Will integration improve the living standards of workers as well as owners of enterprises? Alternatively, one might analyse the impact of integration and MNEs based upon sector analysis e.g. the impact of integration upon the agriculture, manufacturing, and services sectors. Further, will integration change the relative position of particular regions within Africa and the global network? Will integration have specific gender effects upon the relative position of woman in society? Many of these types of questions will often have to be analysed simultaneously to grasp the entire developmental picture. For example, the decline or rise of various industries often has profound regional impacts as well as affecting the general investment and industrial relations climate given. Also during the transition phases of various degrees or stages of integration the assorted costs and benefits, as well as new potential options and enterprise strategies for further integration, will be reflected in the comparative disadvantages of one area or industry relative to the emerging comparative

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advantages of some new geographical area or industry. Being a permanently ongoing process, future inflows and outflows of foreign direct investment and non-equity collaborations will evolve as adjustment occurs. As the potential options are basically unlimited, it makes little sense to attempt to formulate a one-statement general theory covering the adjustment costs and distributional impacts of future African integration processes. It will instead be necessary to focus on the experiences of particular groups, industries or regions towards regional integration in practice based upon sound theoretical knowledge. A major task of all involved will be to generate employment and increased purchasing power. Specifically, Cargill and Shepard (1994, p. 22) argue that: "Generating employment, by increasing black purchasing power, makes strong economic sense. Studies suggest that, given the concentration in black household expenditure on labour-intensive food, clothing and other basic products, a given portion of income spent by black people contributes 10 percent more to GDP than the same amount of money spent by whites."

Finally, focusing on South Africa, there is substantial evidence of an overall positive potential impact of foreign firms on technological progress and general living standards conditional on the following elements: • •

a coherent national science policy needs to be implemented; political priority to provide workable factor markets that do not form bottlenecks during the catch-up process; • continuing progress being made in educational attainment and the use of knowledge capital and absorption capabilities; • technology generation is more and more based on global considerations, despite the concentration of innovations in a handful of countries and enterprises. (Burger (1999))

Thus, MNE activities often are complementary to the needs of indigenous business activities and permit by way of integration (e.g. in supply chains) the achievement of internal economies of scale, which lower the costs of production. Integration activities of MNEs may also bring about the attainment of external economies of scale through access to cheaper capital and superior technology. Due to the flexibility and efficiency advantages of external economies of concatenation catching-up processes are generated which serve as powerful driving forces for economic development and structural accommodation and social upgrading processes vis a vis other group members. Applied effectively sustained competitive advantage becomes a real life option. Taking these factors into consideration will prove to be most relevant as the world moves on along the path of regionalism towards a new and prosperous multilateral trade and investment agenda in the upcoming future.

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REFERENCES Agodo, Oriye (1978). The Determinants of U.S. Private Manufacturing Investments in Africa, Journal of International Business Studies, Vol. 9 (3), pp. 95-107. Aharoni, Yair (1971). On the Definition of a Multinational Corporation, Quarterly Review of Economics and Business, 11 Jg., Bd. 3, pp. 27-37. Alchian, A.A., Demsetz, H. (1972). Production, Information Costs, and Economic Organization, American Economic Review, Vol. 62, No. 5, December, pp.777-795. ANC (1994). The Reconstruction and Development Programme, Unayamo Publication, Johannesburg. Andersson, T., Svensson, R. (1994). Entry Modes for Direct Investment Determined by the Composition of Firm-Specific Skills, Scandinavian Journal of Economics, 96, pp. 551-60. Antonelli, Cristiano (1998). Localized Technological Change, New Information Technology and the Knowledge-based Economy: The European Evidence, Journal of Evolutionary Economics, 8, pp. 177-198. Arrow, K.J. (1962). The Economic Implications of Learning by Doing, Review of Economic Studies, 29 (June), pp. 155-173. Arrow, K.J. (1975). Vertical Integration and Communication, Bell Journal of Economics (Symposium on the Economics of Internal Organization), VI(1), pp. 173-184. Behrens, M., Rimscha von, R. (1994). Gute Hoffnung am Kap? Das neue Afrika, Edition Interfrom, Zurich, Fromm, Osnabriick. Behrman, Jack N. (1962). Foreign Associates and Their Financing, in: Mikesell, Raymond F. (Ed.), U.S. Private and Government Investment Abroad, Eugene, Oregon, pp. 77-113. Blank, Michael (1996).Wirtschaftliche Verflechtungen deutscher mittelstandischer Unternehmen mit der Republik Sudafrika, Europaische Hochschulschriften: Reihe 5, Volks- und Betriebswirtschaft; Bd. 2014, Peter Lang, New York.

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6 GERMAN MULTINATIONALS IN AFRICA B. M. GILROY 1 and N. BAUER 2 1 2

University of Paderborn, Germany MGilroyQnotes.upb.de University of Paderborn, Germany

6.1 INTRODUCTION This Chapter begins by briefly examining the historical background and influences of colonialism upon the international production strategies of MNEs in Africa with a special focus on German multinational enterprises (MNEs) and their activities in South Africa. This backdrop offers the basis for an understanding of the relevance of foreign direct investment (FDI) and globalisation; investments; a general view of South Africa's economic performance; German MNEs in South Africa; the importance of small business enterprises (SMEs); and the interrelating connections of the above listed elements to institutional and subjective aspects of the initial FDI decision in South Africa.

6.2 AFRICA AND COLONIALISM The African continent has always been challenged in many ways through time. Be it slavery, colonialism, political conflicts, famine, diseases or like most recently globalisation Africa appears to be confined in its struggle. A total population of 778 million people is living in 53 countries. The outright economic performance is growing at 2.5 percent per year. Economically, the average GDP of Africans is US$ 639 and at a declining rate. At the same time, over 130 percent of Africa's annual GDP is required to service its financial debt. Ironically, despite Africa's vast sources in natural minerals and human capital, it often hinges on western multinational operations with their technology to exploit its main vantages. Without a process of industrialisation it seems that there is no hope. However, industrialisation is tough in a place where 65 percent of its total population live in rural areas. In contrast, globalisation may well have contributed to some degree towards the trend of urbanisation as noticed by du Toi (1999).

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Clive (1975:328) found that between 1938 and 1960, manufacture grew at 7.9 percent per annum in Africa, compared to 4.8 percent in the developed countries. In the following decade Southern and North Africa - 33 percent of the continent's population - accounted for over 70 percent of its manufacturing and mining output. East, West and Central Africa - 67 percent of the continent's population - made up for 28 percent of those sectors. This progressing trend could also be maintained until the beginning of the 1970s averaging a 6.5 percent growth rate in manufacturing which coincided with an overall growth in GDP of 4.3 percent. Most of the important multinational enterprises (MNEs) activities in Africa are in the manufacturing sector together with the production of minerals for exports. Albeit there has always been significant MNE contribution in farming. Clive (1975:335) notes that their activities in the field of agriculture is diminishing relatively, besides in areas like food processing and farming inputs such as fertilisers. Generally speaking, the prevailing status of Africa's industrialisation strategy lies in light manufacturing industry, the assembly of consumer goods. It is expected by Clive (1975:349) that "in time as the market expands this will induce a continuous backward expansion to intermediate and heavy industries." He (1975:358) postulates that the success of this strategy will bank on Africa's political circumstances. Clive (1975:337) suggests four basic alternative strategies to enhance Africa's independence from MNEs: •

Localisation of senior management and administrative staff i.e. Africanization, • Requiring foreign firms, to raise a substantial part of their capital requirements from the domestic capital market through the issue of local equities; • State participation through the establishment of a national institution in competition with foreign enterprise in the same area of activity, • and state participation in the ownership structure of foreign capitalistic firms through a majority-share ownership. Market size, economic growth, access to financial capital and a stable market orientated policy combined with the basic equipment of a sound infrastructure are the prerequisites most often mentioned in literature for attracting FDIs. Thus, FDI can act as a catalyst for industrial development as Markusen and Venables (1999) explicitly analysed. It must also be stressed that the rates of return for most operating MNEs in Africa generate much higher gains than in other regions in the world. At the same time, it seems that the exploitation of humans, natural resources and weak environmental standards remains also to be very lucrative for investments. The relevance of such misperceptions regarding FDI in Africa will be discussed more explicitly below in Section 8.

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Still many political leaders argue that Africa's stalemate emanates from the marked period of colonialism. By the end of the 19th century, the conference of Berlin manifested the crucial fate of the black continent. In particular, Germany, the United Kingdom, Prance, Portugal and Belgium, the main colonial powers, exerted the right to subordinate the African continent to a private and commercial enterprise namely the International Association. Gatter (1986:77) shows that in the official "Generalakte" the mainly European countries explicitly authorised themselves to claim, exploit and "civilise" the African continent. Goux and Landeau (1971) divided African countries' into five categories depending on the level of investments: colonies, protectorates, condominia, counties on the road to annexation, and independents. In this context, colonies were those countries in which the direct investments of one metropolitan country represented 30 percent or more of GNP and independents showed a 1 percent share. In Africa, three French "colonies" (Gabon, PR of Congo, and Mauritania) , two British (Swaziland and Zambia), two US (Liberia and Libya) and one Belgian (Zaire) could be identified in 1967 according to the Goux-Landeau scale. A slow process of de-colonisation took place only for a few countries. In the case of Germany, East Africa, Southwest Africa, Cameroon and Togo were colonised. Alike Germany, other European colonists engaged in Africa in order to tap on its abundance in natural resources and to secure new export markets. Of course, the priority to prosper from colonial exports in minerals to European countries appeared to be of increasing importance as European imports did not show the expected outcome. This reflected the early strive to gain world market shares. In fact, the infrastructure to deliver the extracted resources from the interior to the coastal area was non-existing. The building of railways in Africa did not link the whole country but laid the foundation for an infrastructure and greater mobility. German's export of wagons and tracks rose from 9.4 percent in 1884 to 37.1 percent for wagons in 1912 and from 17 percent to 58 percent for tracks in the same period. Schinzinger (1984:123) notes that about 26.074 km of active railway tracks had been established by 1904. Also, schools, hospitals, streets, and public utilities were provided by German colonists. Meier (1986:63-65) and Timm (1981:200) show that trade between the German Hanse and the new African colonies entailed the foundations of many trading companies like the German-Westafrican in 1896, the South-Cameroon Society; i.e. Woermann, Norddeutsche Bank, and Esser in 1898, the NorthwestCameroon Society in 1899. There was a strong colonial lobby due to the creation of colonial associations and societies by the end of the 19*^ century in Germany.

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In most of the four German colonies plantation production dominated and employed about 100.000 African people. However, diamonds, India rubber, vanadium, tin, gold and iron and wild life achieved greater impetus in time. Between 1884 and 1912 most important German imports from its colonies were crude cotton, India rubber, cupper, and iron. Especially trade in India rubber and iron increased exorbitantly. Schinzinger (1984:125) enunciates that in terms of the German colonial relationship, German industry was clearly dependent on imports, however, exports from its African colonies remained relatively low as they could not satisfy the demand of the German textile and electronic industry. In turn, the demand for goods from Europe was relatively low in the colonised countries. Understandably, trade premised on European standards could not be easily matched with the indigenous manner of commercial trade. Schinzinger (1984:138) points out that there had not de facto been a great deal of trade experience outside of Europe prior 1884 by the German industry. Therefore, as many other European countries in Africa, German traders were not familiar with the African want pattern. Interestingly, Schinzinger (1984:139) finds that customs regulations between Germany and its African colonies were characterised by high mutual tariff rates. However, both sides alleged that an increase in imports from the colonies as of the German Reich could only be created by the reduction of duties. There was no free trade between the colonies and the home country as among the German colonies. Thus, trade did not increase as expected. This demonstrates as Schinzinger (1984:142) concludes the necessity of investments in infrastructure. An investment in that specific sector does eventually cause spatial and societal development. Such a process could have easily culminated in an increase in the volume of trade. Such an approach can even be found today among African and developing countries. In the wake of colonialism most MNEs pertained a monopoly position. Hveem (1975:68) noticed that France held a monopoly position in 12 African countries in 1967 with 7 out of 12 being highly penetrated by FDIs. The UK occupied a similar position in 8 African countries with 4 being highly penetrated and the US had a monopoly in Libya and the UAR. Hveem (1975:70) points out that over the half of FDIs in Africa were in raw material extraction. For example, BP/Shell's investment in the Nigeria petroleum production was the biggest corporate holding in Africa's extractive business in 1967. Roughly 23 percent went into manufacturing and petroleum refining. The service sector accounted for 27 percent of total FDIs. The activity of MNEs and colonialism consequently shaped the economies of the present day African countries. In manufacturing, technology usually takes the form of a finished product to be marketed directly or assembled on the spot with pre-fabricated parts

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produced and created from some other affiliates of the corporation. According to the international product cycle theory products are produced according to the wants of the most sophisticated consumers in developed markets. In time, and after reaching economies of scale production other developing markets are furnished with these products. Notably, Hveem (1975:78) posts that the African pattern is mostly the last phase in the product cycle. This may to a large extent be due to the deficits in absorptive learning capacities of indigenous enterprises which prohibits an effective technology transfer and ignition of the needed catch-up processes (see further Chapters 1,2,4,7 and 10 of this volume). As a matter of fact, there is very little R&D activities in the subsidiaries of foreign companies in Africa. The essential creation of technology, knowledge and information is mostly performed at the headquarters in the developed countries and hence leaves Africa functionally dependent on the technology transfer by foreign corporations. Various authors, such as Hveem (1975:80), have even advised that African countries "must gradually dissociate themselves from those countries and their agencies, notably the multinational corporations. Only by associating more with each other and on relying more on themselves can development be achieved." Especially "for the extractive sector, where producer associations are needed, and for the processing one, where there is an urgent need for a conscious strategy of industrialisation and cooperation on planning, research and development, marketing sharing , etc., between underdeveloped countries" the need for regional integration and transcontinental cooperation loom large. To conclude, transfer of technology through the multinational corporations may not lead necessarily to industrialisation, but in turn entails the exploitation of domestic capital, natural resources, and of the labour force. To escape from the colonial dependency du Toi (1999) provides four initiatives for a more sustainable Africa, namely: (1) Increased awareness of the plight of the poor; (2) The concept of an African Renaissance; (3) Regional energy cooperation, and (4) Eco-tourism. Nowadays, multinational enterprises from the USA, Japan, Europe and slowly also from African countries enter not only the market for resources but also commence to produce for the domestic African market instead. The process of a sustainable development relies on whether the planning and the growth of the industry culminates in a transformation of the four elements of underdevelopment which features most African nations as provided by Hveem (1975:75): (1) Foreign penetration and a resultant external dependency; (2) Disintegration of the economy; (3) Mass poverty and lack of resources at the level of the national economy; and (4) Gross inequalities in an economic, cultural and political sense.

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Finally, the African Development Report 2000 categorises the African postindependence economic growth record into five periods. First 1965 - 1973, a period of rapid economic expansion. Second, 1973 - 1980, period of adjustment due to the oil shock and world recession. Third, 1980 - 1985, period of adjustment due to external shocks like high global interest rates. Fourth, 1986 - 1995, applying of structural adjustment programmes (SAP). Fifth, 1995 1999, a phase of fragile economic recovery in the post period of the Asian crisis. The broad picture shows a declining economic performance in contrast to other regions like East and South-East Asia, which are characterised by environments and infrastructures permissible to rapid knowledge and technology absorption. A recent sensitivity study on trade shocks and macroeconomic fluctuations in Africa by Kose and Riezman (1999: 18) has calculated estimates suggesting that "more than 44 percent of the variations in aggregate output is explained by trade shocks. Surprisingly, the world interest rate fluctuations have a minor effect on economic dynamics. Through impulse responses, we find that trade shocks prolonged recessions in these economies. Our sensitivity analysis suggests that the most significant impact of trade shocks is on the dynamics of investment in the model economy." Interestingly their results suggest further that financial shocks play only a minor role.

6.3 FDI AND GLOBALISATION There is a widely perceived negative stereotype of Africa as an investment country. A closer view however, will transmit a disparate picture. Africa is made up of over 50 different countries with a variety of historic, political, societal and economic atmospheres. Despite the truth of some devastating detriments and external shocks it has to suffer, the stereotype is misleading. The content of the UNCTAD report 1999 on Foreign Direct Investment in Africa: Performance and Potential propounds the African situation as follows. "Although it is true that the overall economic performance of Africa was unfavourable for a long time and Africa did not benefit from the FDI boom that began in the mid-1980s, there are a number of positive but little-known facts about Africa, such as the considerable improvement by African countries of their FDI policy frameworks, investment opportunities discovered by firms in new home countries, significant investment in the services and manufacturing sectors and in particular the high profitability of FDI in Africa. Given this, it should not be surprising that a more differentiated analysis reveals a number of countries that have been successful in attracting FDI and shows that Africa - as any other continent - offers attractive investment opportunities which can be enhanced by host countries, and supported by home countries and internal initiatives (UNCTAD 1999a, viii-ix)."

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Indeed, Africa's returns on investment averaged 29 percent since 1990. Even in terms of profitability Africa ranked much higher than countries like Japan, the US and UK as demonstrated by UNCTAD (1999a:17). Ironically, such opportunities did not have a profound effect on FDI decisions by MNEs. So far, Africa has gained merely 1 percent of the global FDI flows. In 1999, Africa accumulated $10.3 billion of FDI. The top recipient countries were Angola, Egypt, Nigeria, South Africa, Morocco, Mozambique, Sudan, Tunisia, Cte d'lvoire and Gabon. Especially, Morocco and South Africa could more than double their FDI inflows from 1998 to 1999. However, this might also have been reason to the process of privatisation of federal corporations and structural adjustment programmes. Among the FDI front runners are Botswana, Equatorial Guinea, Ghana, Mozambique, Namibia, Tunisia and Uganda. In 1996, one quarter of all FDIs were received by these seven countries which make up only one-tenth of the continent's population and GDP. Notably, besides the increase in FDIs most of the front runners also show GDP growth rates above 5 percent. As noticed in the World Investment Report 2000: Cross-border Mergers and Acquisitions (M&As) and Development from UNCTAD FDI in Africa is very concentrated in almost only five countries but with a different composition of FDI transfers. Recently, the main force behind the surge in FDIs are crossborder M&As driven by strategic corporate objectives due to the decentralisation of state property. South Africa and Egypt are the main favoured locations for FDI, but also Mozambique, Uganda, the United Republic of Tanzania and Ethiopia are in the locus for investments. At the same time a survey by UNCTAD (2000a:9) indicated that African FDIs will continue to increase significantly until 2005. Another survey by UNCTAD (2000b) and the International Chamber of Commerce on transnational corporations (TNCs) in Africa point out that FDIs are no longer confined to the primary industry. Oil-exporting countries, services and manufacturing are the key industries today. In particular, Figure 6.1 demonstrates the insight of some 296 questioned TNCs on prevailing corporate opportunities in Africa listed by the importance of the industries. On the other side, FDI outflows from African countries are increasing and reached $935 million in 1999 from $648 million in 1998. The same can be observed in the case of South Africa where FDI outflows amounted $1.1 billion in 1999. As some African companies have turned into international competitive TNCs, they now diversify and start to serve the African market from abroad. For example, South African Breweries, Sappi Ltd. and Barlow Ltd. are among the list of UNCTAD's largest 50 TNCs in developing countries. As risks and uncertainties are on average at a higher rate when MNEs operate in a foreign market, the OECD countries - the major sources of FDI nations -

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IPetroleum, gas and related products; Telecommunicationand tourism followed by agriculture and motor vehicles. petroleum, gas as well as mining, quarrying, agriculture, forestry and West Africa telecommunicationareas. East Africa Tourism and telecommunication. Central Africa Mining, quarrying and forestry. Tourism, transport and storage followed by telecommunication, SouthernAWca mining and quarrying, metals and metal products, motor vehicle, food and beverages, pharmaceutical and chemical products and agriculture.

North Africa

Source: UNCTAD (2000b:2). Fig. 6.1. Market Opportunities for TNCs in Africa

signed a Multinational Agreement on Investments (MAI). Tandon (1999:12930) summarised the fundamental impacts of MA1 for Africa. " African governments will have no control whatsoever over how foreign capital comes into their countries and how and in what sectors it operates. There will be no obligation on it to transfer technology, none to hire local workers at managerial or lower levels, none to purchase from local sources, none to allocate a certain percentage of its production for local or external markets. Foreign capital will have better than "national treatment" when it comes to repatriating profits; better protection against any possible threat of appropriation by the state; and a guaranteed access to courts to demand compensation in cases of such appropriation. He adds "[wlhen it comes to disputes settlement, besides extra-territorial access to local courts, the aggrieved corporations will be able to secure the assistance of their home countries to impose "cross-retaliatory" sanctions to ensure that their investors are not in any way disadvantaged in Africa." Without doubt, such an agreement does clearly take responsibilities away from federal institutions and reflect the ongoing predominance of the old colonial powers in a world of increasing factor mobility. The present policy by the World Trade Organisation (WTO) may further marginalize Africa as it will continue to lose bargaining power due to restricting and impelled international provisions.

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6.4 INVESTMENTS Mundorf (1993) discussed five indirect effects of FDIs to the economic development of a country. First, there is a technology transfer that can be of financial, personnel, consulting or licensing nature. Second, FDIs commonly refers to large capital imports. In the case of South Africa the first phase of investments are conducted mainly with foreign capital. The second phase of investments are financed through the gains of the operations. Third, project or start-up investments entail the transfer of management. Consequently, there are considerable differences in wages among local management and expatriates. The transfer appears to be necessary, as highly qualified managers are not sufficiently available on the local market. Policies like black empowerment or affirmative action offset the drawbacks from the elderly regime but questions labour productivity. Fourth, effects of job creation and real capital formation is provided due to an improvement in the supply of the domestic market as local companies may source from a greater variety. Fifth, FDIs may also effect export diversification. Since multiplication effects are prevailing there can be positive as well as negative impacts. In order to enhance the positive effects Mundorf (1993:130) names six points that are regarded as the indirect FDI determining conditions: • • • • • •

Economic framework Investment incentives Local market size Economic resources of the foreign market Traditional trade relations and market proximity Economic and political stability

However, among the developing and less developed countries it is acknowledged that some negative effects must be accepted if FDIs are desired. In the 1960s major investments flows occurred from the German MNEs and SMEs in South Africa. Especially many firms of the supply industry of the chemical and automobile industry followed their major customers to South Africa. Many production facilities were set up close to production and supply plants. Mundorf (1993:216) argues that these major investments were conducted despite the radical political situation in South Africa as the government provided many investment incentives. The high interest of FDIs by the South African government can be explained in the attempt to establish an electrical, automobile and chemical industry. In those days, FDIs can be characterized as import substituting for raw materials. Although the geographical distance between both countries is huge transportation costs play a minor role for investments as pointed out by Holthus et al. (1974:158). He defines German companies as defensive investments takers,

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i.e. investment decisions are based on the action of the competition. But that seems to be questionable in the case of South Africa where trade and historical links exist for a long time. So, German companies appear to be offensive investment takers. Interestingly, Mundorf (1993:220) discovered that German subsidiaries with an asset of 20 to 70 million DM are generally investing in thrusts. The contribution of Holthus et al. (1974:12) suggests that with an increase in FDIs there is a parallel rise in foreign production visible. Further various studies based upon questionnaires have revealed that German FDI is principally market driven. Gilroy and Broil (1987:5) classify the German industrial sector which engages in FDI by the dimension of technological intensity, the size of the firm, high intra-industry concentration rates and hence an intensified level of competition. One may quote Gilroy and Broil (1987:13) for the motifs of German FDI activities: "It is perhaps interesting to note that South Africa, as the only industrial land of the black continent, has despite the increasing level of political instability since 1983 received more German investment capital than during the more peaceful years of the past. This investment strategy is in strict contrast to the industrial investment policies of most other industrialised nations who have preferred not to support the apartheid system. Apparently, the long-run prospect of a rapidly expanding market in South Africa has achieved the overhand in the strategic planning of German multinationals active in South Africa compared with the short-run risks of political instability and shifts of powers." During the 1980s Giitschleg (1999) noticed a surge of German investment in South Africa. In the same period UN sanctions against South Africa increased. Unlike German companies, which tried to counteract the detriments of the apartheid system, US firms started to pull out of South Africa. In the 90s the activity of German companies was constant. German companies are aware of the fact that South Africa is highly profitable in labour-intensive production. Giitschleg (1999:186) found that about 90 percent of German companies are planning to increase their engagement in South Africa. However, 72 percent of investments are financed out of the corporate cash-flow. Leverage or loans financing from the parent company account for only 12 percent. The ratio of local loan employment is very low since high interest rates exist. Many German firms also engaged in currency management or hedging since the volatile Rand was regarded as a financial uncertainty. Moreover, 52 percent of investigated companies were planning to expand their production lines, respectively (Giitschleg (1999:200)). On average, asset value increased by 12 percent from 1994 to 1996.

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Generally speaking, Gilroy and Broil (1987:14) stress the internationalisation of German MNEs due to three motifs. First, firms have merged, purchased or set up foreign production to secure foreign markets for their commodities. Second, the strategy of securing raw materials in foreign markets for the production process in the home country. Lastly, the increasing intra-nrm division of labour generated cost differences. South Africa: Foreign Assets 1994 -1998 60

>. 5 0 (0

1 40

-0-Total Foreign Assets ^ ^ Direct Investment -a- Other Investments — Portfolio Investment

w = 30 o = 20 .a

1994

1995

1996

1997

1998

Years

Source: International Monetary Fund (2000:183)

Fig. 6.2. Gilroy and Broil (1987:13) noticed that "German multinational investments have to a large extent consisted of horizontal investments. The establishment and development of integrated markets has promoted rationalisation of operations within the political restrictions on a horizontal basis, allowing German firms to obtain economies of scale through an international division of production. This tendency of outward-looking strategies of German multinational will continue to intensify world competitive intensity levels in the future." Total foreign assets more than doubled four years after South Africa's democratic process began. South African direct investment flows have increased by 44 percent from 1994 to 1997. Also, an overwhelmingly surge in portfolio investments from US$ 0.1 billion portfolio capital, which is very volatile and traded at the stock market, rose to US$ 7.8 billion in less than five years as illustrated by Figure 6.2 above. Major investors over the last years in South Africa are the USA, Malaysia, the UK, Germany, Japan, France, Italy and Switzerland. Most FDIs went into manufacturing, telecommunication, energy, transport and consumer good in-

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dustries. From 1997 until 1999 German FDI went up from 733 million DM to 1202 million DM. As noted by the Deutsche Bundesbank (2000) this amount accounts for almost 44 percent of overall German outward flows to developing countries. German corporations further played an important role for society. Mundorf (1993:248-49) indicated that German subsidiaries identified in advance the need for investments in the education and health system just as housing and social welfare. During the time of sanctions against South Africa German FDIs had a positive effect on employment and satisfied the basic needs of its workforce. At the same time, Pabst (2000) found that since 1997 there has been an upsurge in investments and job creation. Again further commitment to investments and job creation exists by German MNEs. That is also true for labour market issues like the black empowerment and affirmative action. It has, however, also been found that these provisions are reasons for the low productivity due to the inefficiency aspects of an mainly unqualified black workforce.

6.5 A VIEW OF SOUTH AFRICA'S ECONOMIC PERFORMANCE The expected economic and political vacuum after the African National Congress (ANC) took power in 1994 evaporated quickly. Today, the South Africa's economy is still in transition and on the right track. The economic shift from a resource based economy to a financial and manufacturing orientated one reveals South Africa's catching-up process. The Economist (2001:13) gives a sound economic overview that mirrors South Africa's economic performance by the onset of the 21 st century. South Africa's strategy embarked on an open-economy policy by reducing tariffs and engaging in regional integration schemes of SADC and most recently with the EU. These alterations on macroeconomic level can be observed by its growing rate of the GDP which has, after some external shocks, recovered quickly in 1998 and is expected to generate a 3.5 percent growth rate this year. However, a 5 percent growth rate is needed in order to absorb new entrance to the labour market in South Africa. In this context, the tertiary sector contributes 64.9 percent to GDP, followed by the secondary sector by 24.5 percent and finally the primary sector with 10.6 percent. Notably, that composition of GDP resembles that of many industrialised countries. The South African inflation rate came down to 6 percent. This also reflects that consumer prices have improved considerably during the last years. Furthermore, South Africa's budget deficit was successfully diminished from 8

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percent in 1994 to an estimated 1.9 percent in 1999 by means of privatisation of public corporations like the Telecom and Sun Air. Yet, the process of privatisation is a sluggish one and government failed in handling the right procedures to meet with its own intentions to offset the budget deficit so far. Of high economic interest are the decisive foreign direct investment (FDI) flows. Attracted by the ongoing process of decentralisation most FDIs could be sourced from the US, Malaysia, the UK, Germany and Japan. Nevertheless, South Africa received merely 0.4 percent of the world foreign direct investment flows in 1997 according to the Industrial Development Corporation (IDC) in the South African Business Guidebook (2000:88). In comparison to other similar countries Brazil gained $106 billion, Argentina $252 billion and even Chile could attract $333 billion in the period from 1994 1999. In the same period, South Africa experienced a FDI outflow exceeding its inflows by $1.6 billion. One major reason for this is the need for international capital by larger South African companies like Anglo American, Billiton, Old Mutual, South African Breweries and Dimension Data. A further rise can be expected for the coming years for political stability and further interregional integration in Southern Africa is said to pertain high potential fillips. On the other side, FDI flows are believed to create new industries and jobs. The Economist (2001) projected the current unemployment rate between 35 and 24 percent. Federal labour policy pursues a black empowerment policy with the affirmative action at its kernel. Due to the dualistic nature of South Africa society it surely seems difficult to quantify an objective figure but the urgent need for a surge in employment remains an unquestionable priority for the post-Apartheid regime. The success story of South Africa is most often contributed to the Growth Employment and Redistribution (GEAR) strategy implemented in 1996. Its' targets included a 6 percent growth of real GDP and a job creation over 400.000 by 2000. Even if not all ends were met so far, GEAR contributed considerably to a new economic South African atmosphere as argued by Halbach (2000:28). Additionally, Drechsler (2000:39) sees the result of the sound fiscal and political reform process in the upgrading of South Africa's listing by the American rating agency Standard & Poor to BBB. Eventually, this will buttress the future for essential FDI inflows for South Africa.

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Government's 2000/2001 budget still projects to continue the path of GEAR. Notably, however, are the more reasonable adjustments. GDP growth is projected at 3.5 percent, budget deficit estimated at 2.6 percent of GDP, and inflation rate is set at 3 percent to 6 percent by end of 2002. Furthermore, a broad tax reform can be found on the agenda. Even the heavy weighted debt servicing ratio is projected to drop to 4.9 percent of GDP in 2003 as presented in the "SA 2000-01: South Africa at a Glance" report ( S.A. 2000-01:94). There is no doubt that economy wise South Africa will continue to lead the continent in the near future, but the extent will primarily be determined by its ability to master the profound societal issues on crime, AIDS, education and income distribution which now represents the countries major economic detriments.

6.6 GERMAN MNEs IN SOUTH AFRICA There are strong historical and commercial ties of over a century between Germany and the Republic of South Africa. Historically, a host of German pundits in the field of mineral extraction and commercial trading already engaged in South Africa at the outset of the 19 century. Figure 6.3 shows some of the early German commercial involvements in SA. Today, still about 30 percent of the white population pertains of German descent, i.e. around 1 million people. In this context, Mundorf (1993) differentiates two groups of German South Africans. First, German-Afrikaners who have a long relationship, interest and local roots in South Africa. Second, there are about 90.000 Africa-Germans who still hold a German citizenship and live in SA principally due to economic reasons. Also, cities like Heidelberg, Wuppertal, Heilbron, and Frankfort still reflect the profound German influence in SA. Economically, Germany already became the second most important trading partner for South Africa in 1914. A temporary setback due to the aftermaths of the two world wars occurred but did not damage the established relations. German firms seem to work within an institutional network through a consultancy infrastructure, which has evolved over time. For example, there is about 13 institutions like the German Chamber of Commerce, the Goethe Institute, the Association of German Engineers (VDI), the South African Initiative for German Business (SAFRI) etc. which support the German industry and its community. Another example provided by Mundorf (1993) is the establishment of the Deutsch Afrika Linien (DAL) in 1934 which still runs the export business for companies like Audi, BASF, Degussa, Hoechst, MAN, Mercedes, Volkswagen and Demang-Duisberg. As many others, Gilroy and Broil (1987:1) see the rapid rise of German MNEs in the process of market expansion, product diversification and vertical inte-

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I

1852 1868 1895 11912

I

1930s 1948 1949

I

1950 1958

I

Dr. Otto Landsberg Josef and Adolf Momthal Hamburgian company SIEMENS

AEG Ernest Oppenheimer (A@O &erican Corp.) Mannesmann Demag

VoUtswagen Union of German Exporter and Importer Association BASF partnership with SASOL Mercedes-Benz, East London

I I

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Export of tobacco

T*gmmpmy Trading company Electric industry in Cape Town Supply industry Diamond company - -

I II

Steel and Coal refining industry

1

/

Automobile production Predecessor of SA-German Chamber of Industry and Commerce Coal refining plant Automobile production

Source: Mundorf, Dirk (1993:108 -1 12); Giitschleg, Dirk (1999:12) and expanded by the authors. Fig. 6.3. Historical Engagement of Germans in South Africa

gration. Consequently, market size and growth due to an import substituting strategy together with the membership of regional integration schemes with an export orientated production made South Africa recently to an attractive production and export platform. Interestingly, Siemens and AEG started to run their business operations even before the industrialisation process in South Africa emerged. The post-war period can be classified as a period for the German automobile, electronic, chemical and its supply industry. Precisely, the intensification of the relations between the two countries began in the 1960s and is still continuing. The South African - German Chamber of Commerce provides a fairly detailed number of German companies in South Africa. It has been noticed that the number of German companies in South Africa varies around 560 firms employing roughly 65.000 people. Most of these enterprises can be identified to operate in the secondary sector. Giitschleg (1999) identifies the machinery, electronic, chemical, pharmaceutical, automobile, and metal production sectors as the major hosts for German firms respectively. Also important are some 90 SMEs in these sectors, followed by 68 businesses operating in the tertiary

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sector. Giitschleg (1999:81) finds that the average German firm has been operating in South Africa for 22 years. The major industrial areas of South Africa can be found in the Pretoria-Witwatersrand-Vereeniging (PWV) region, the Durban-Pinetown region, the Port Elizabeth-Uitenhage region, East London and the Cape peninsula. Of all German companies Giitschleg (1999:91) identified 89 percent in the Gauteng region, six percent in the Eastern Cape, four percent in the Western Cape and only one percent in Kwazulu-Natal. Blank (1996:224) sees a potential for the Johannesburg and Pretoria region to become an international hub which is characterised by an excellent transport and infrastructure, sound trade experience, well established tourism and financial markets. He adds further advice to operate in neighbouring and Asian growth markets where many, in the medium run, business opportunities for MNEs prevail. Nevertheless Mundorf (1993:166) points out that the process of industrialisation encompasses the intensification of regional inequalities. In regard to employment it must be noticed that about 3.8 percent of German MNE's aggregate global employment labours in South Africa. According to Mundorf (1993:199) AEG, BASF, BMW, Bosch, Mercedes Benz, Siemens and VW are the big job creators and are located at different spots in South Africa. The location of German companies hinges on the decision to set up a production plant or to gain stakes in a local company. Giitschleg (1999:90) investigated that 96 percent of business German enterprises favour the private company as the type of business, whereas 82 percent of all German firms started as greenfield operations and only 18 percent engaged in participation with local companies. In terms of management, the implementation of German management appears to be prevailing in every company. Mundorf (1993:218) sees a trend of German companies to engage in collaborations, strategic alliances or in a takeover of management by purchasing the majority of shares. Further, he noticed that nearly all German subsidiaries strive for the majority of shares in order to control, coordinate and exert own commercial activities and decisions. It can be asserted that the purchasing power of the black population will increase further in the future. Hence, a new market orientation towards black consumers for financial, technical or institutional services is needed. Local supply of the South African market appears to be more important than production for export by most MNEs. However, Giitschleg (1999:71) points out that South Africa is to gain significantly as an investment country due to the free trade agreement and open market orientation. The main reasons for engaging in new markets by German firms are determined by an internationalisation strategy, the strive for increasing international division of labour, the financial interconnection, the securing of markets and the surmounting of trade restrictive barriers. Whereas factor, trans-

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port, and production costs, the political situation together with investment incentives, the infrastructure and natural resources play second priority for investment making. South African firms expect a higher intensity of competition due to the opening up of the economy in comparison with German firms. Naturally, German firms know the European market quite well and are familiar with its export patterns. Thus, German firms are in competition with imports from EU and other foreign companies in South Africa. In particular, there is a fierce competition from South-East Asian countries experienced in South Africa by German firms. By sectors Giitschleg (1999:138) found, for example, that German automobile companies do not consider themselves to be competitive without tariff protection in South Africa. This might be reason to the diminishing local content programmes which have been reduced since its introduction in 1961 in order to support South Africa's automobile industry. Generally, firms with production facilities fear anti-dumping cases. On the other hand, it is possible that MNEs without a production facility may undercut prices and sell their corporate production surplus at variable cost prices. The automobile production and its supply industry had to face reducing profitability and turnovers as protecting tariff duties have been abolished and new competition appeared on the market. In contrast Giitschleg (1999:202) noticed that German companies in the field of construction, engineering and metal processing have improved their economic situation considerably. Interestingly with regard to his findings concerning South Africa's opening up of its economy and integration into the global market, he found that German and South African corporations perceive themselves to be internationally competitive enough to be successful in the near future (Giitschleg, 1999:144). The literature offers various in-depth inquiries on German multinational enterprises (MNEs). For example, Pabst (2000), Giitschleg (1999), Halbach (1998), Blank (1996), Mundorf (1993) and Falk (1986) elaborate on disparate economic issues of German MNEs operating in South Africa. Figure 6.4 above depicts the recent features of the success of German production companies in South Africa, which will be deployed to scrutinize German producing MNEs perception provided by Giitschleg (1999). Giitschleg (1999) compares German companies ex-ante and ex-post of the democratisation process in South Africa. Quadrants 1, 2 and 3 illustrate the positive effects to improve the location advantage of South Africa. Partially important are the promotion of SMEs and the privatisation of federal corporations. As important are the SA-EU free trade agreement (FTA), macroeconomic strategy of government, and the reform for capital transfer perceived. In quadrants, 4, 5 and 6 are the influencing factors, which will remain relatively constant until 2001. Among important issues one can find the relationships with unions, investments into infrastructure, reform of customs duties

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fcd

4 - Adjustment of the rules of competition - Reconstruction and Development Programme (RDP) -SACU -SADC - Federal investment support

1 - Promotion of small and medium sized enterprises (SMEs) - Privatisation of federal stakes

8 - Affirmative Action - Labour Relations Act - Inflation - Unit wage costs 5 - Relation to unions - Investments in infrastructure - Internal political stability/ instability - Reform of import restrictions and duty rates - Corporate tax reform - Real interest rate 2 - SA-EU FTA - Macroeconomic strategy of government reform of capital transfer policy

partially important

important

9 -Crime - Available qualified work force - Currency stability 6

3

very important

IMPORTANCE FOR THE SUCCESS OF GERMAN COMPANIES regarding profitability and growth Source: Gutschleg, Dirk (1999: 208). Fig. 6.4. Influencing Factors of the Success of German Production Firms and taxes, and finally the interest rate and the political stability. Not much change is expected from the SACU, SADC, Reconstruction and Development Programme (RDP) and investment incentives provided by government. Especially the insufficient productivity of the workforce as the accountability of unions are determined as the major hardships which South Africa has to cope with to become more attractive for foreign investors as noted by Pabst (2000:15).

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Finally, quadrant 8 and 9 depict the major issues affecting the location advantage of South Africa as perceived by German companies. Important are the labour relations acts like affirmative action, but also inflation and real labour unit costs have profound impacts on German companies' returns. Most importantly however are the drawbacks due to violence and crime, the qualification of the workforce and the currency value to the DM for German companies. Also, Pabst (2000) conducted six surveys over the period from 1994 until 2000 on German companies. In his last survey he found that the overall results concerning investments, job creation and labour laws were more positive then before. He further noticed an overall positive picture of the economic framework in comparison to the political structures. Negative shifts are presented in only two areas of maintenance of the transport infrastructure and investment incentives over the years. In sum, Pabst (2000:6) noted that only 18 percent of German companies regard the economic climate as good or very good. Simultaneously, the majority values the climate as stable. Pabst (2000:10) analysed the virtues for German companies in South Africa like a market driven economy and a balanced taxation system. In the terms of corporate fillips for operating in South Africa Pabst (2000:15) finds the following features which are of strategic importance to German enterprises in South Africa: • • • • • • • •

reasonable return on investment maintenance of transport infrastructure higher productivity of workforce free competition free transfer of funds abroad accountable labour unions incentives for investments cheap and reliable supply of electricity

Of high concern are crime and violence, environmental matters, and living standards. During the apartheid years American MNEs pulled out of South Africa but invests increasingly into South Africa again today. For the remaining European companies in South Africa a code of practise was established to counteract against the discriminative practices of the apartheid system. Mundorf (1993:229) explains that the EC voluntary code of practise asked for intentional measures to improve the labour market for blacks in order to overcome the system of apartheid peacefully. Its content stressed the internal corporate relations, wage structures, training and education programmes, optional social benefits, furtherance of black businesses and the apartheid at the work place. Giitschleg (1999:162) points out that the main corporate tasks which German company's face is the process of improving their production process and

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the training of the workforce. Notably, in time the average capacity utilisation of German producing industries rose from 76 to 82 percent. German MNEs hold a traditionally long relationship with South Africa. They are familiar with its environment and market climate and have also overcome the rigid system of separation. The perception of German MNEs in South Africa can more or less be projected onto other European companies in South Africa. Thus, since South Africa is dependent on FDIs it must now successfully overcome the internal detriments of crime, violence, justice systems before new jobs are created due to increasing foreign capital. First and foremost, investment decisions in the first half of the 20*'1 century were premised on locationship advantages of South Africa; i.e. production costs, transportation costs, delivery time, favourable exchange rate, arbitrage opportunities in natural resources and protecting customs rates. Today, Mundorf (1993:125) estimates that foreign corporations account for roughly 40 percent of the total production from the private sector in South Africa. The African market consists of over 614 million people. This fact is a major incentive for many corporations operating in South Africa. By and large, German firms marketed state-of-the-art consumer products to primarily white well-off consumers that have the similar wants like European customers. Also investment goods, machinery and appliances are of an up-to-date standard. According to Giitschleg (1999:161) it takes about 11 months for German firms to start producing a new product in South Africa which appeared on the European market. In the meantime, imports are prevailing to supply the market from Germany. Figure 6.6 symbolises Vernon's product cycle theory applied to the German export and import behaviour in the case of South Africa.

Production

I

Consumption

*•

New

Mature product

Standard product

Time

Phases of the Product Cycle

Source: Giitschleg, Dirk (1999:151). Fig. 6.5. Corporate Attitude of German Subsidiaries in South Africa

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In contrast to South African firms, German firms in South Africa usually source their inputs from abroad. German companies are in South Africa to supply the local market, introduce new and diversified products, and increase export activities and for the reason of cost minimisation. Giitschleg (1999:12933) shows that only 5 percent of German activities account for export businesses with Africa. Whereas 24 percent of the turnover accounts for imported commodities. Furthermore, Giitschleg (1999:145) noted that 85 percent of the turnover by German firms is earned in South Africa, only 10 percent outside of Africa and merely 5 percent in Africa. Major import commodities from the EU are machinery, chemical products, specialty goods, transport equipment, base metal and plastics and rubber. On the export side, South Africa trades predominately precious stones, mineral goods, base metal, vegetable and machinery items. According to the International Trade Statistics Report 2000 from the WTO South Africa ranks 36 among the world biggest exporters (even before Portugal; 40) and 40 among importers respectively in 1999. Examining the Transnationality Index of Host Economies for 1997 designed by UNCTAD (2000a, p. 23) South Africa ranks 13th among developed economies. The index measures the average of four shares: FDI inflows as a percentage of gross fixed capital formation for the past three years (1995-1997); FDI inward stocks as a percentage of GDP in 1997; value added of foreign affiliates as a percentage of GDP in 1997; and employment of foreign affiliates as a percentage of total employment in 1997. The main trading countries in Europe with South Africa listed by importance are Germany, the U.K., Netherlands, Belgium, Italy, France and various others. Kappel (2000) noticed that Germany accounts for almost 40 percent of South Africa imports. Exports from Germany include chiefly machinery, assembly parts for vehicle production, and components for the chemical, electrical and iron industry and reflect the South African need for technology and investment goods. Gilroy and Broil (1987:2) name the saturation of the German domestic market and the under-utilisation of its capacities as the reason for the major export activities of German companies. They (1987:3) state that "[t]he process of expansion, diversification, and integration into world markets made the need for more systematic management and ultimately the internalisation of the control function of foreign distribution necessary." Such an integration process must now be pursued by the South African economy. At the same time, they (1987:10) report that the international involvement of German firms enable them to focus on product lines in which competitive advantages exist while semi-finished inputs are primarily imported from abroad. Prior the negotiated SA-EU FTA German exports were treated under the MFN rule, if products were explicitly produced in Germany, i.e. 25 percent of

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all production costs must have been generated in Germany. Falk (1986:62-63) noticed that German exports consist mainly of supply materials to German subsidiaries or partnerships. German exporting companies also benefit from a booming South African economy as delivered machinery and equipment encompasses subsequent orders. Of high importance for German export orientated companies is also the goal to establish a free trade area among the South Africa Development Community (SADC) by 2004. That would create a market of 160 million consumers and further strengthen South Africa's economic position in Sub-Saharan Africa. Moreover, other trade agreements with the MERCOSUR countries, India and Pakistan are pursued.

6.7 SMALL BUSINESS ENTERPRISES German small business enterprises (SMEs) are strongly engaged in South Africa. Federal government as the private sector support SMEs and established the Small Business Development Corporation. Blank (1996:224) states that SMEs are primarily environment takers as they can not to any great extent change their environment in contrast to MNEs. German SMEs are of high importance to South Africa. Within South Africa's industrialisation process German companies provided fundamental contributions in the field of technology transfer, training and development as well as employment. Generally, Mundorf (1993:179) highlights that about 75 percent of jobs are generated within the small business sector. Kaplinsky and Manning (1998) analysed the environment of SME in South Africa. They observed that South African SMEs' share of employment is considerably low compared with other countries. In this context, large firms in South Africa appear to be more responsible for job creation and attain a much higher industrial output than other countries. Blank (1996) provides a salient analysis of German SMEs. He identified the machinery, electronic, chemical, trade and transportation as the major industrial sectors which mirrors the traditional sectors of the German Mittelstand. It was shown that the plastic production, food processing and textile industry is largely underrepresented and still offers business opportunities. On the other hand, chemical, pharmaceutical and health industry is well represented. It has been found that the knowledge of German SMEs regarding the South African market is quite high. Surprisingly, more than 50 percent of questioned SMEs in Germany had already commercial relations with South Africa. He assumes that a remarkable increase in commercial relations between Germany and South Africa will take place. This argument can be buttressed when one

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considers the recent establishment of the SA-EU FTA and its impacts on German MNEs as surveyed by Bauer (2001). Blank (1996:290) points out that there is an overwhelmingly high interest of German companies to establish an international production plant in South Africa. Nevertheless, due to relative scarcity in resources in terms of capital, personnel and specific market knowledge German SMEs favour cooperations without financial participation, joint ventures, and licensing. In turn, Blank (1996) assumes that with an increasing cultural distance to the potential host country investment decisions will be made on a personal and rational stage within the SMEs. As a consequence, the establishment of crucial commercial relations and the sound exchange of information among both countries weigh much more importance to promote the production location of South Africa. In 1996, German SMEs in South Africa had to deal with corporate obstacles emanating from its business environment. By priority, upheavals and political climate, lack of qualified local management, currency regulations, qualification of workforce, labour policy and unions, infrastructure, incentives for investments were regarded as the major hindrances for economic growth. Thus, it seems understandable that about 40 percent of all small business regarded their investment as an developing aid. According to Blank (1996) German SMEs value the South African market positively due to its geographical position, sound infrastructure network and financial sector, and for its independent central bank. Negatively regarded are restrictions on the repatriations of profits, regulations on currency trade, unions and labour policy, low education levels of the black population, and the political instability. Mundorf (1993:220) also observed that during recessions, rationalisation and substitute investments by SMEs were conducted. Especially in the textile, leather and upstream added value chain like in the special chemical commodities industry expansion investments occurred. Due to the traditional links between German and South African companies and the SA-EU FTA an increase in intercontinental trade and FDI can be expected. The manufacturing sector in particular will sustain more attraction by German MNEs and SMEs. Notwithstanding, South Africa is compelled to compete with other investment seeking countries notably in Asian and South American countries. As a result, it is an imperative to face South Africa's major internal difficulties which still are reason to deter essential investors from engaging in the sub-Saharan market as discussed briefly below in Section 8.

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6.8 INSTITUTIONAL AND SUBJECTIVE ASPECTS OF THE FDI DECISION IN SOUTH AFRICA The world is becoming more and more regionalized and the future growth potential of South Africa is becoming evident. To a large extent it is still highly unclear what exactly will be the effects of these institutionalised attempts at creating a "global consciousness" which hopefully one day may result in a sustainable prospect of a universal, peaceful world unity. As pointed out by Stalker (2000) these efforts are not something new and spectacular, but rather the results of a centuries-long process and the outcome of deliberate choice. However, as noted, we are still a long way from achieving a world economic and political unity based on harmonised principles and accepted "rules of the game". The "death of geography" and the "demise of the nation-state" are not around the corner as some would believe even though we daily experience the deepened penetration of foreign media and the world-wide distribution of "lifestyle" consumer products that contribute to some sense of a global consumer culture (or perhaps a loss of culture?). For example, the leading global brand in 1996 was judged to be McDonald's, with 19,000 hamburger restaurants located around the world, followed by Coca-Cola, Disney, Kodak, and Sony (Kochan (1996, p.83)). These integration processes may however, as demonstrated repeatedly by history, become disrupted when subjective perceptions reach certain thresholds. Taking MNEs to be one of the major vehicles of global integration processes, let us now briefly discuss what factors determine an enterprise's initial foreign direct investment in a given location such as South Africa. Much of the literature on this topic is characterised by its descriptive nature. Earlier contributions on this subject offer no real synthesis of the MNE as an economic agent, modelled and interpreted in the light of economic theory. Many of the earlier attempts to describe the behaviour of why firms invest abroad have generally been based on simple questionnaire methods, which are open to much justified criticism (compare e.g. Aharoni (1966) who developed an explanation of the decision to go abroad which places almost total reliance on subjective preferences, further Barlow and Wender (1955), Behrman (1962), Behrman (1962, 1969), Brash (1966, Chapter 3), and Kayser and Schwarting (1981)). Dunning (1973) has critically reviewed this "survey approach to FDI" and demonstrated the difficulty in obtaining a clear demarcation line between investment motives and factor determinants based upon such simple questionnaire methodology. That much of the evidence, at first glance, appears to be of contradictory nature is largely due to the nature of the decision to "go abroad". The answer to the question "What determines an enterprise's initial foreign investment decision?" is to a large extent founded in subjective or behavorial and institutional variables as well as traditional economic variables

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NAFTA

USA/ Mexico Border

179

Tumen River Area

ASEAN

Examples of International Zones and Regions: . Major regional bodies or regional institutions

A

International agreements between parts of countries Existing growth zones

o

Future potential growth

Source: Mirza (1998, p. 5) Fig. 6.6. Tendencies Towards Regionalization: Some Examples

and motives (see e.g. Williamson (1981, p. 1538), Richardson (1971, p. 8)). The neglection of subjective aspects thus leads to apparent confusion when confronting the empirical evidence of the survey approach method. Illustrative of the deficit in economic behavorial analysis of real world entities (which may indeed not be representative average units as commonly postulated) is the fact that economists have often paid little attention with regard to the supply of entrepreneurs and their role of specialisation in the application of judgement to solve efficiency problems (compare Casson (1982), Giersch (1982)). An accepted theory of entrepreneurship is still in its infancy. The MNE may be regarded as a specialised institution tailored to global problem-solving activities (Hennart (1982), Casson (1982)). Problem-solving is a basic human activity. As common to nearly all topics that lie in the spectrum of questions concerning international economic transactions, one may postulate that problem-solving makes relatively intensive use of various human facilities which are either more abundant or better developed in some individuals, who therefore have a comparative advantage in problem-solving. Gains to specialisation arise which may be further enhanced if economic agents specialise in solving different types of problems. The MNE may thus be interpreted as an internal market or hierarchial structure for global problem-solving facilities as inherent in the very complex entrepreneurial functions of these firms (compare e.g. the so-called "headquar-

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ters" function H in Helpman (1984), or Johansson (1982)). Problem-solving is, however, more complicated than simply decision-making theory postulates. As Giersch (1982, p. 3) has suggested: "No theory can explain economic development if it assumes that alternatives or options are given and then proceeds to concentrate on formal maximisation techniques. I suggest that we do almost the opposite: Leave the solution of maximisation problems to a mathematical slave and computer and concentrate on - search activities and search strategies and - criteria for options which deserve exploration and for avenues that should be left aside because they are most likely to be dead ends." The point is that it is not necessarily the abundance or shortage of resources and information alone that is relevant to an initial investment decision, but the way the resources are managed and interpreted. The complexity of the international environment (compare e.g. Mueller (1986), Rycroft and Kash (1999)) combined with the scarcity of time for an entrepreneur or an entrepreneurial team implies that the exploration of possible international production sites such as South Africa must to a large extent be completed by means of judgement which is still full of intuition. In what follows, a brief framework is presented which has been developed by Richardson (1971) capable of incorporating heuristically many of the relevant economic as well as subjective foreign direct investment decision variables in a generalised fashion. Enterprises are postulated to be endowed with a set of spatial preferences analogous to traditional time preferences, a set of objective functions, and some behavioral rules which determine when an inertia of rest will be overcome and "motion" will begin such that the enterprise makes the decision to begin with offshore production. The model formulates a foreign direct investment objective function which may be applied to derive a graphical illustration of a decision curve for FDI which demonstrates how subjective perceptions and constraints may affect entrepreneurial responsiveness. Within the model, the effects of intra-firm trade may also be discussed.

6.9 INERTIA, SPATIAL PREFERENCE AND PRODUCT PREFERENCE "In the psyche, inertia is seen as a tendency towards habit formation and ritualization... essential for the sense of stability and permanence which is the basis of consciousness.

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Every pattern of adaptation, outer and inner, is maintained in essentially the same unaltered form and anxiously defended against change until an equally strong or stronger impulse is able to displace it" (Whitmont (1969, p. 147)). The law of inertia states that a body at rest will tend to remain at rest unless disturbed by some external force. To what extent the external force induces motion depends upon the size of the body, the intensity of the external force, and the presence of any friction or "internal resistance" (which has the effect of stabilising the position of rest). Behavioral phenomena, such as FDI, may be interpreted applying the law of inertia. An activity not being undertaken unless the situation is disturbed by some external stimulus which overcomes the initial inertia resistance of economic agents will continue not to be undertaken. The degree to which some external stimulus such as future potential growth of profits induces or reduces factor mobility may be viewed in the light of the law of inertia. Regarding the FDI decision inertial resistance is due to "spatial preference" such that enterprises possess a natural preference to maintain the operations of established domestic production sites as opposed to considering alternative international production locations. In order to overcome the additional risks associated with international operations enterprises must perceive some potential risk premium which is sufficiently large to overcome their "rate of spatial preference". Spatial preference rates will vary according to the location area being considered. Therefore, due to the aspect of inertia and subjective spatial preferences, equal international profit opportunities will not be judged as identical among investors. Important to note is that offshore production sites must be characterised by potential profit opportunities which are greater than alternative locations by at least the rate of the respective locational spatial preference rate. A FDI decision therefore underlies the forces of inertia and subjective spatial preference. In addition, one could postulate that the inertia and subjective preference concepts are also applicable to an enterprise's product preference. Consider a firm facing the decision to produce a commodity within an already existing product line or the introduction of some new product outside of the firm's established product mix. Given such a constellation, venture investments in new product lines require, due to inertial aspects, an exogenous stimulus in the form of perceived potential profits which are at least as great as the rate of product preference existing in the established product line manufacturing.

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6.10 A FOREIGN DIRECT INVESTMENT OBJECTIVE FUNCTION For each potential international location site of FDI an enterprise may be characterised to possess an objective function of the simple form,

u = u(n), du/an > o

(6.i)

such that U expresses a measure of subjective valuation and 77 the locational site potential or effective long-run average profits (thus eliminating for simplicity reasons problems of actual profit variations). Excluding intermediate production for the moment, a specific functional form of equation (6.1), which may be summed across all production sites, leads to a single objective function of a truly MNE, U = n13,

0 < /? < 1

(6.2)

in which (3 represents the spatial preference or inertial resistance variable. Existing production locations are characterised by /3 = 1, thus effective profit rates determine the locational value. Markets in which manufacturing of the specific enterprise under consideration have not yet occurred will be characterised by (3 < 1. In order for an enterprise to contemplate entering this new market a premium (equal to II — II @) is needed to overcome the relative states of inertia. Market areas completely outside the firm's planning horizon exhibit f3 = 0. The variable j3 , then, is the subjective variable on which the amount and direction of FDI depends. Unfortunately, the subjective variable j3 is not explicitly observable. However, changes in j3 may to some extent be predicted: as general information flows on some specific investment location and its environment becomes more available (increased profit rates, reductions in crime rates, increases in locational per capita incomes, and the various other variables stated above in Figure 6.4 etc.), (3 will also increase reducing thereby the necessary premium required for an initial FDI action.

6.11 A DECISION CURVE FOR FDI As MNEs attempt to optimise the rate of return on the usage of internal and external resources and information flows, one may argue that the institutional organisational form "multinational enterprise" is revealed preferred due to the institutional advantages which permit cost minimisation along with value maximisation due to the specificity of assets (compare e.g. Markusen (1984), Markusen and Melvin (1984)). As Williamson (1981, p. 1548) has argued,

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"The first principle of efficient organisational design is this: the normal presumption that recurring transactions for technology separable goods and services will be efficiently mediated by autonomous market contracting is progressively weakened as asset specificity increases." The decision to invest abroad most often encompasses some sort of market analysis (see e.g. Behrman (1969), Berninghaus (1986)). Given that some calculated rate of return (U) is greater than some target rate of return (U*) FDI will occur. As Richardson (1971, p. 12) points out, this is obviously not a maximisation criterion for investment per se, but rather in accordance with much of the survey literature approach as to how these decisions actually are made. Applying the objective function as illustrated in equations (6.1) and (6.2) above, as well as the target return rate U* it is now possible to derive an enterprise's foreign direct investment decision curve. Setting U = U* and substituting price, average cost, and unit sales for IT one obtains, U* = U[{p-c)S]

(6.3)

with p = price, c = average cost and S = sales (the market motive). Equation (6.3) is an implicit function of average costs and sales for a given price and spatial preference which generates a locus of average cost and sales satisfying U = U*. Applying the specific form of equation (6.2) above one obtains a locus of all sales and cost combinations which make a foreign direct investment just attractive enough to the enterprise to overcome its initial inertia: the foreign direct investment decision curve as plotted in Figure 6.8. In Figure 6.8 it is assumed that enterprises that become internationally active possess a certain degree of market power such that pmin represents some form of mark-up pricing. Enterprises are assumed to have control over prices to the extent that they expect to receive a price which is at least equivalent to the product's domestic price plus the price of exporting the commodity to the foreign market. The establishment of pmin is thus dependent upon the alternative costs of a pure export sourcing strategy. Given that an enterprise's spatial preference has been subjectively determined and further that the enterprise has carried out its market analysis the locus U in Figure 6.8 may be interpreted as a foreign direct investment curve such that if the empirical market analysis establishes that the sales-cost point falls beneath the curve actual returns will be greater than target returns (U > U*). Foreign direct investment will occur. The horizontal intercept of the decision curve varies with the level of spatial preference or inertial resistance demonstrated by any specific enterprise.

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C, p,

Investment

not undertaken Investment undertaken

Sales

P.

Source: Richardson (1971), p. 13. Fig. 6.7. A Decision Curve for Foreign Direct Investment Higher levels of spatial preference, as measured by a smaller (3 , shifts the intercept and decision curve to the right reducing thereby acceptable sales-cost combinations: foreign direct investment becomes less likely to occur in this market. Note that enterprises, due to their subjective spatial preference, may choose not to implement otherwise economically profitable opportunities. Points above the decision curve yet below the line pmin are profitable sales-cost combinations, however, due to the subjective nature of the decision to go abroad investment does not occur.

6.12 FORCES THAT CONSTRAIN RESPONSIVENESS "...psychic inertia manifests itself as resistance to change, however desirable such change may be." (Anthony Stevens (1983, p.274))

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"Much of our fear is a fear of a change in the status quo, a fear that we might lose what we have if we venture forth from where we are now people find new information distinctly threatening, because if they incorporate it they will have to do a good deal of work to revise their maps of reality, and they instinctively seek to avoid that work. Consequently, more often than not, they will fight against the new information rather than for its assimilation." (M. Scott Peck (1978, p. 274)) Both firms and markets are two institutions that attempt to organise economic activities. The establishment of an internationally active firm leads to changes in the behavior of the economic agents by modifying the nature of constraints on their activities. The entity MNE is an evolutionary adaptation to the allocative problem of scarce world resources (Williamson (1981), pp. 1537-1568). Within the MNE organisational structure constraints exist which permit rapid forms of adjustment to overcome possible divergencies between the interests of individuals and that of the firm's ultimate goal, long-run profit maximization. The speed of response of social actors and social systems will also effect the value of any steady-state analysis (Tuma and Hannon (1984), pp. 10-11). However, in assessing the importance of MNEs as a means of optimising behavior which minimises transaction costs it must be noted that the origins of such constraints often are to be found in influences and motives not normally included in the domain of neoclassical economic studies (compare Williamson (1981), p. 1538). The MNE permits quick adjustments to changing world circumstances, such that even disturbances of a rather large magnitude often produce only short periods of disequilibrium. Little is unfortunately known about speeds of adjustment, yet existing theory does give proof of forces that constrain responsiveness. Tuma and Hannan (1984, p. 11) classify two broad classes of inertial forces reflecting the costs of change and those that reflect institutional mechanisms. As they point out, economists traditionally stress the former. The common argument being that uncertainty associated with the potential gains from radical change seldom offset the fairly certain costs of change in terms of additional resources consumed and time and effort spent for searching for an optimum. Sociologists (compare e.g. Gafgen and Monissen (1978)) and the more institutionally oriented economist profession (e.g. Furubotn and Pejovich (1974), Furobotn and Richter (1985)) tend to emphasize institutional constraints tacit assumptions about goals, rights, and rules of action. Social structures such as a MNE are highly institutionalised when its members take rules as given in formulating and making decisions. Institutionalisation greatly reduces

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the costs of surveillance, coordination, and control of action, thereby increasing the efficiency of collective action. Given that an organisational form such as the internal market structure of an enterprise is well suited to deal with prevailing international conditions, institutionalisation in the form of multinational structure promotes efficiency in collective activities. On the other hand, one should not forget that the fact those institutionalised structures may act as powerful brakes on attempts at changing rules and patterns of action. In sum, inertial forces are commonplace. At times, the costs of change will hinder adaptation more than institutional constraints, and vice versa. In either case the speed of response to a complex changing international environment will depend largely upon the effectiveness of the entrepreneurial function. There are commonly high levels of risk involved when action on the international level is called for, forcing the entrepreneur to judge them in relation to alternative possibilities. Under the assumption that no shortage of entrepreneurial talent exists (see Giersch (1982)) the existence of the organisational form MNE is to a large extent due to the existence of institutional resistances along with technical requirements which make it necessary for a combination of specialised persons to overtake the entrepreneurial role.

6.13 INTRA-FIRM TRADE: THE EFFECTS OF INTERMEDIATE PRODUCTION "Intra-firm" trade in manufacturing estimated to be as high as fifty percent in certain areas, is trade transacted between affiliated parties and is usually trade in intermediate products. As enterprises realise the increasing potential for integrating their production world wide, they are contributing to shifts in the pattern of international trade and investment flows. International trade and international investment are thus inextricably linked to international production. Arm's length trade on spot markets between independent buyers and sellers is being commonly complemented by intra-firm trade between affiliates of the same enterprise. The incentive for such trade may be considerably different between industries and countries, however, international trade in resource-based industries is illustrative. The basis for such trade is a simple division of labour between the growing or extraction of a product and its subsequent processing (compare e.g. Siebert and Rauscher (1985)), permitting greater specialisation and eliminating possible (negative) externalities. In order to include intermediate or extractive industries into the above presented analysis Richardson (1971, p. 14) reformulates an investor's objective function (equation (6.1) and (6.2) above) as,

6 GERMAN MULTINATIONALS IN AFRICA U = U[(p-c)S1,(ca-c)S2]

187 (6.4)

with S\ = sales to other firms, S2 = intra-firm trade, that is shipments to the parent firm, and ca represents the average cost of alternative sources, less the cost of importing from the foreign country. A specific functional form of equation (6.4) is e.g.,

where fii and /% represent the respective spatial preference or inertial resistance parameters. Analogously a decision curve for investment in intermediate production may be derived from equations (6.4) and (6.5). Setting U = U*, price equal to the minimum expected price for sales to firms and S2 equal to the input requirement in the domestic production process (given values of /3i and fa ) determines a foreign direct investment decision curve as illustrated in Figure 6.8.

c,p

Investment not undertaken Investment undertaken

S,

Source: Richardson (1971), p. 14Fig. 6.8. A FDI Decision Curve in Intermediate Production

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As noticed by examining Figure 6.8 above, the introduction of intra-firm trade into the analysis does not influence the slope or concavity of the FDI decision curve. Introducing intermediate production does, however, make it possible may be for the curve to have a vertical intercept, such that Ca — -—^ positive. The market motive for foreign direct investment is no longer always necessary to motivate FDI. Instead the motive of securing low cost inputs through vertical integration may push the value of foreign investment beyond U*. Smaller values of fa inferring increased spatial preference shift the decision curve to the right (and not up) such that it may still be the case that profitable projects are rejected for subjective reasons. In summary, Richardson (1971) has demonstrated in a simple model how the FDI decision curve is a function of the values of the parameters for target returns (£/*), minimum expected price in the foreign market (pmin), and spatial preference for inertial resistance (/3). These parameters are likely to be highly variable in reality. He argues that strictly "economic" theories of FDI can be generated with his model by assuming constant subjective variables. However, most significantly spatial preference or inertial resistance may be affected through numerous factors. In this respect, informational and subjective perceptual aspects of the decision making process play an important role, as well as the institutional setting in which an enterprise operates. Insufficient information or misperceptions regarding international locations and their institutional environment leads to a low /? threshold. It has sometimes been argued that one of the main reasons for the failure to make an initial FDI is commonly that the enterprise simply does not perceive the foreign opportunities available (e.g. Richardson (1971), Safarian (1966, p. 5), Barlow and Wender (1955, pp. xxii-xxiii) ). The empirically observed practice of first entering a new international market via firm export-sourcing policies results in a higher level of information that eventually usually shifts the decision curve to the left in the graphs. On the other hand, a poor investment climate as expressed e.g. in possible or potential political or exchange rate instability, high crime rates, or even disturbances in geographical bordering countries will increase the respective locational risk level and shift the decision curve to the right such that FDI projects may become nearly non-existent.

6.14 CONCLUSIONS As has been noted above, Africa's return on investment averaged 29 percent since 1990. Even in terms of profitability Africa ranked much higher than countries like Japan, the US and UK as demonstrated by UNCTAD (1999a:17). Ironically, such prospects have yet to have a profound effect on FDI decisions by MNEs. So far, Africa has gained merely 1 percent of global FDI flows. In 1999, Africa accumulated $10.3 billion of FDI. This situation is apparently often based upon either a lack of information or misperceptions and what

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one might perhaps refer to as "belief perseverance" in the face of contrary evidence. How can it be that ten years of an average 29 percent rate of return on investment in Africa is not being adequately registered by the "global" managers of MNEs? Apparently, as Cole (1998:53) has pointed out: "the efficacy of evidence as a factor in changing management's working assumptions is much overrated. It takes an awful lot to overcome deeply held core beliefs. Yet, faith in the power of evidence underlies the rational actor model. To parahrase Bourdieu, members of the top management group share common histories and share a similar "habitus", creating regularities in thought, aspirations, dispositions, patterns of appreciation, and strategies of action linked to their particular positions in the organisational structure. The instincts of people in such a system serve to reproduce behaviour, not change it." Although foreign investors remain wary of entering Africa in general, South Africa has indeed been relatively successful given the legacy of the apartheid's system and its political transition to a liberal democracy. The fundamental economic indicators for South Africa are largely positive (as recently expressed by the American rating agency Standard & Poor's "BBB" ranking of South Africa) and rescinding international trade and investment restrictions should have the expected profound long-run effects on the economic structures of society given that the necessary social policies also begin to take hold and improvements become visible. The South African inflation rate was registered at 5.3 percent in 1999, the lowest rate recorded during the last thirty years (Lohse and Barkemeyer (2000)). South Africa also managed relatively quite well through the 1998 Asia Finance Crisis without the aid of the International Monetary Fund due to their well-structured banking system and solid economic policies followed. The psychological and subjective effects upon foreign investment of political developments in directly neighbouring countries such as Zimbabwe, as well as further African problem areas such as Angola and DR Congo will, however, still need to be watched carefully in order to prevent increasing "Afro-pessimism". As South Africa catches up, there are even signs of increasing outflows of FDI from South African MNEs. For example, in the information technology sector the South African enterprise Dimension Data is now successfully operating in 36 countries in five continents. According to its management, they are also one of the first foreign companies to get a 1.3 million dollar contract with China to implement an E-Commerce-Portal for Business-to-Business in the household appliance industry. Anglogold, the world's largest producer of gold and second largest mining company in the world (some 7.5 million ounces gold annually, with some estimated 365 million ounces total resources) purchased the Australian enterprise Acacia Resources last year and collaborates in two

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joint ventures in Africa, as well as producing in Argentina, Australia, Brazil, and the USA (Lohse and Barkemeyer (2000)). South Africa has taken on the role as the engine of growth for the region with her economy being some four times as large as all other fourteen South African Development Community (SADC) states combined (Halbach (2000)). Indeed, much of the future developments in the region will to a large extent depend upon the interdependence between subjective and real economic variables of the FDI decisions made by MNEs discussed above and the challenge of reading the signs correctly. Especially the strong historical and commercial ties of German MNE activities in South Africa will continue to be a major factor and to offer a thriving impetus to the ongoing integration transition processes. However, as has been discussed theoretically investment by German firms in South Africa seems to be stagnating and enterprises increasingly view increasing crime, inflation and the depreciation of the Rand as a restraint to further investment. A theme, which is analysed further, based upon a qualitative survey of German enterprises active in South Africa in Chapters 7 and 8 of this volume.

REFERENCES AFRICAN DEVELOPMENT BANK (2000). African Development Report 2000, Oxford: Oxford University Press, [On-line], URL: http://www.afdb.org. Aharoni, Yair (1966). The Foreign Investment Decision Process, Harvard University Press, Boston. Barlow, E.R. and Wender, I.T. (1955). Foreign Investment and Taxation, Prentice-Hall, Englewood Cliffs. Bauer, Norbert (2001). The EU-SA Free Trade Agreement - Impacts on German Multinationals, University of Paderborn: Diplom-Thesis. Behrman, Jack N. (1962). Foreign Associates and their Financing, in: Mikesell, Raymonf F. (Ed.), U.S. Private and Government Investment Abroad, University of Oregon Books, Eugene. Behrman, Jack N. (1969). The Multinational Enterprise and Nation States: The Shifting Balance of Power, in: The Multinational Corporation, Department of the State, Office of External Research, March, Washington. Behrens, Peter (1985). The Firm as a Complex Institution, Zeitschrift fiir die gesamte Staatswissenschaft, Bd. 147(1), March, pp. 62-76.

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Berninghaus, Siegfried (1986). Die Gittens-Index Methode: Ein Neues L6sungsverfahren fur Entscheidungsprobleme bei unvollstandiger Information, Rheini-sche-Friedrich-Wilhems-University, Bonn, Discussion Paper No. A-38, January. Blank, Michael (1996). Wirtschaftliche Verflechtungen deutscher mittelstandischer Unternehmen mit der Republik Siidafrika. Betrachtungen vor dem Hintergrund einer Theorie der Internationalen Produktion, Frankfurt am Main: Peter Lang. Bourdieu, P. (1981). Men and Machines, in: Knorr-Cetina, K. and Cicourel, Aaron (Eds.), Advances in Social Theory and Methodology, Routledge and Kegan, Boston, MA, pp. 304-318. Brash, Donald T. (1966). American Investment in Australian Industry, Australian National University Press, Canberra. Casson, Mark (1982). The Entrepreneur: An Economic Theory, Martin Robertson, Oxford. Clive, Thomas Y. (1975). Industrialisation and the Transformation of Africa. An Alternative Strategy to MNC Expansion, in: Amin, Samir and Widstrand, Carl (ed.) (1975): Multinational Firms in Africa, New York: Africana Publishing Company, pp. 325 - 360. Cole, Robert E. (1998). Learning from the Quality Movement: What Did and Didn't Happen and Why?, California Management Review, Vol. 41, No. 1, Fall, pp. 43-73. Deutsche Bundesbank (2000). Deutsche Netto-Kapitalanlagen im Ausland nach ausgewahlten Landergruppen und Landern 1997 - 1999, in: Zahlungsbilanzstatistik, Frankfurt/Main: Deutsche Bundesbank. [Online] at URL: http://www.bundesbank.de from November 1, 2000. Drechsler, Wolfgang (2000). Siidafrikas Wirtschaftspolitik erntet Lob, aber wenig Geld, in: Finanzen und Wirtschaft, Nr. 1, 6 Januar 2000, p. 39. Dunning, J.H. (1973). The Determinants of International Production, Oxford Economic Papers, 25(3), pp. 289-336. Du Toi, Joan (1999). CHINA, AFRICA, RUSSIA, INDIA. Forecasting Scenarios, Transcript in: Whole Earth, Spring, 1999.

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Falk, Dieter (1986). Deutsche Direktinvestitionen in der Republik Siidafrika aus betriebswirtschaftlicher und steuerlicher Sicht, Offenbach/Main: Ursula Schoning Verlag. Furubotn, Erik G., Pejovich, Svetozar (1974). The Economics of Property Rights. Furubotn, Erik G., Richter, Rudolf (1985) (Eds.), 2nd Symposium On the New Institutional Economics, Zeitschrift fur die gesamte Staatswissenschaft, Bd. 141(1), March. Gafgen, Gerard, Monissen, Hans G. (1978). On the Usefulness of Sociological Paradigms - Reflections on Sociology's Models of Man from an Economist's View, Jahrbuch fur Sozialwissenschaft (Zeitschrift fur Wirtschaftswissenschaften), 29, pp. 113-144. Gatter, Frank, Thomas (1986). "Die Berliner Afrika-Konferenz von 1884/85. Ein Beitrag zur kolonialen Ordnung", in: Hinz, O., Manfred; Patemann, Helgard and Meier Arnim (Hrsg.), Weiss auf Schwarz. Kolonialismus, Apartheid und afrikanischer Widerstand, Berlin: Elefanten Press, pp. 76 - 78. Giersch, Herbert (1982). The Role of Entrepreneurship in the 1980's, Kieler Discussion Papers, Institut fur Weltwirtschaft, Kiel, August. Gilroy, B. Michael, Broil, Udo (1987). "German Multinationals", Multinational Business Quarterly, No. 1, pp. 1-11, and available as: Intemationalisierung der Wirtschaft, Sonderforschungsbericht 178, Serie 11, Nr. 19, Fakultat fur Wirtschaftswissenschaften und Statisitik, Konstanz: Universitat Konstanz. Goux, Christian and Landeau, Jean-Franois (1971). Le peril americain, Paris: Calmann-Levy. Giitschleg, Dirk (1999). Deutsche Unternehmen im neuen Siidafrika, Berlin: Deutscher Industrie- und Handelstag. Halbach, Axel J. (2000). Siidafrika im Jahr 2000. Wirtschaft und Politik unter President Mbeki, in: Ifo Schnelldienst, 53. Jahrgang, No. 30, 2000, pp. 27 - 34. Halbach, Axel J., Rohm Thomas (1998). Das neue Siidafrika. Wachstumsimpulse fur den schwarzen Kontinent?, Miinchen: Weltforum Verlag. Helpman. E. (1984). A Simple Theory of International Trade with Multinational Enterprises, Journal of Political Economy, Bd. 92, pp. 451-471.

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Hennart, J. (1982). A Theory of Multinational Enterprises, Ann Arbor, Michigan University Press, Michigan. Holthus, M. (Hrsg.), Jungnickel, R., Koopmann, G., Matthies, K., Sutter, R. (1974). Die Deutschen Multinationalen Unternehmen. Der Internationalisierungsprozefi der deutschen Industrie; in: Wirtschaft Aktuell, Frankfurt/Main: Althenaum. Hveem, Helge (1975). The Extent and Type of Direct Foreign Investment in Africa, in: Hinz, O., Manfred; Patemann, Helgard and Meier Arnim (Hrsg.), Weiss auf Schwarz. Kolonialismus, Apartheid und afrikanischer Widerstand, Berlin: Elefanten Press, pp. 59 - 91. International Monetary Fund (IMF) (2000). South Africa. Selected Issues, in: IMF Staff Country Report, No. 00/42, March 2000, Washington, D.C.: IMF, [On-line], URL: http://www.imf.org. Johansson, J.K. (1982). A Note on the Managerial Relevance of Interdependence, Journal of International Business Studies, Winter, pp. 143-145. Kaplinsky, Raphael and Manning, Claudia (1998). Concentration, Competition Policy and the Role of Small and Medium-Sized Enterprises in South Africa's Industrial Development, in: The Journal of Development Studies, Vol. 35, No. 1, October 1998, pp. 139 - 161. Kappel, Robert (2000). Schatten der Zukunft, in: Freitag, [On-line], URL: http://www.freitag.de/2000/37/00370701.htm from 08.09.2000. Kayser, Gunter, Schwarting, Uwe (1981). Foreign Investments as a Form of Enterprise Strategy: On the Results of a Survey, Intereconomics, November/December, pp. 295-299. Kochan, N. (1996). The World's Greatest Brands, Interbrand/Macmillan Business, New York. Kose, M. Ayhan, Riezman, Raymond (1999). Trade Shocks and Macroeconomic Fluctuations in Africa, CESifo Working Paper Series, Working Paper No. 203, November, pp. 1-43, http://www.CESifo.de . Lohse, Maren, Barkemeyer, Rena (2000). Stop and Go am Kap, Aktienresearch, Nr. 23, May 31, pp. 80-83. Markusen, J. (1984). Multinationals, Multi-Plant Economies and the Gains from Trade, Journal of International Economics, Bd.16, pp. 205-226.

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Markusen, J., Melvin, J. (1984). The Gains-from-Trade Theorem with Increasing Returns to Scale, in: Kierzkowski, H. (Ed), Monopolistic Competition and International Trade, Oxford, pp. 10-34. Markusen, J. R. and Venables, A.J. (1999). Foreign direct investment as a catalyst for industrial development, in: European Economic Review, Vol. 43, No. 2, pp. 335 - 356. Meier, Arnim (1986). Der Aufstieg des Handelshauses C. Woermann, in: Hinz, O., Manfred; Patemann, Helgard and Meier Arnim (Hrsg.), Weiss auf Schwarz. Kolonialismus, Apartheid und afrikanischer Widerstand, Berlin: Elefanten Press, pp. 63 - 65. Mirza, Hafiz (Ed.). Global Competitive Strategies in the New World Economy: Multilateralism, Regionalization and the Transnational Firm, Edward Elgar, Cheltenham, UK, Northampton, MA, USA. Mundorf, Dirk (1993). Bedeutung von Investitionen deutscher Industrieunternehmen fur die Wirtschaft Siidafrikas, Europaische Hochschulschriften, Vol. 1361, Frankfurt am Main: Peter-Lang Verlag. Mueller, Dennis C. (1986). The Modern Corporation: Profits, Power, Growth and Performance, Harvester Press, Sussex. Naiman, Robert, Watkins, Neil (1999). A Survey of the Impacts of IMF Structural Adjustment in Africa: Growth, Social Spending, and Debt Relief, Preamble Center, April, http://www.preamble.org/IMFinAfrica.htm , (01.03.00). N.N. (2000). SA 2000-01: South Africa At a Glance, 6th Edition, Craighall, Editors Inc. Pabst, Giinter (2000). Sixth Survey of German Enterprises in South Africa, Johannesburg: Deutsche Industrie- und Handelskammer fur das siidliche Afrika. Richardson, J. David (1971). On "Going Abroad": The Firm's Initial Foreign Investment Decision, Quarterly Review of Economics and Business, Winter, pp. 7-22. Ross, L., Lepper, M. (1980). The Perseverance of Beliefs: Empirical and Normative Considerations, in: Shweder, Richard (Ed.), Fallible Judgement in Behavorial Research, Jossey-Bass, San Francisco, CA. Rycroft, Robert W., Kash, Don E. (1999). The Complexity Challange: Technological Innovation for the 21st Century, Pinter, New York.

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SA 2000-01. South Africa at a Glance, 6th Edition, Craighall, Editors Inc. Safarian, A.E. (1966). Foreign Ownership of Canadian Industry, McGrawHill, Toronto. Schinzinger, Francesca, (1984). Die Kolonien und das Deutsche Reich. Die wirtschaftliche Bedeutung der deutschen Besitzungen in Ubersee, Stuttgart: Franz Steiner Scott Peck, M. (1978). The Road Less Travelled, Simon and Schuster, New York. Siebert, Horst, Rauscher, Michael (1985). Vertical Integration by Oil-Exporting Countries, Intereconomics, September/October, pp. 211-216. South Africa Business Guidebook 1999 - 2000, 4th Edition, WriteStuff Publishing, pp. 83 -89. Online Available at URL: http://www.guidesa.co.za Stalker, Peter (2000). Workers Without Frontiers: The Impact of Globalization on International Migration, ILO, Lynne Rienner Publishers, Boulder, Colorado. Stevens, Anthony (1983). Archetypes: A Natural History of the Self, Quill, New York. Tandon, Yash (1999). Globalisation and Africa's Options. Part two, in Journal of Development Economics for Southern Africa, Vol. 1, No. 6&7, May to December 1999, pp. 109 - 135. The Economist (2001). South Africa, 24 February, pp. 3 - 16. Timm, Uwe (1981). Deutsche Kolonien, Munchen: Autoren Edition Verlag. Tuma, Nancy Brandon, Hannan, Michael T. (1984). Social Dynamics: Models and Methods, Academic Press, New York. United National Conference on Trade and Development (UNCTAD) (1999a). Foreign Direct Investment in Africa. Performance and Potential, Washington D.C.: UNCTAD. United National Conference on Trade and Development (UNCTAD) (1999b). World Investment Report 2000: Cross-boarder Mergers and Acquisitions and Development, Washington D.C.: UNCTAD. United National Conference on Trade and Development (UNCTAD) (2000a).

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World Investment Report 2000. Cross-border Mergers and Acquisitions and Development, Washington D.C.: UNCTAD. United National Conference on Trade and Development (UNCTAD) and the International Chamber of Commerce (ICC) (2000b): World's Largest Transnational Corporations Cautiously Optimistic about Africa's Potential for Attracting Foreign Direct Investment, Press Release TAD/INF/2839, 15 February 2000, Online Available at URL: http://www.unctad.org/en/press/pr2839.en.htm from 7 October 2000. Whitmont, E.C. (1969). The Symbolic Quest, Barnie & Rockliff, London. Williamson, O.E. (1971). The Vertical Integration of Production: Market Failure Considerations, American Economic Review, Papers and Proceedings, pp. 112-123. Williamson, O.E. (1981). The Modern Corporation: Origin, Evolution, Attributes, Journal of Economic Literature, Vol. XIX, December, pp. 1537-1568. WORLD TRADE ORGANIZATION (WTO) (2000). International Trade Statistics 2000, Geneva, WTO.

OBSTACLES FACING GERMAN ENTERPRISES IN SOUTH AFRICA B. M. GILROY ET AL.1 University of Paderborn, Germany

7.1 INTRODUCTION1 The lack significant FDI flows to Africa has prompted relatively little scientific discussion (for exceptions see e.g. Loots, 2000; 1999; Lall, 1998 and Bhattacharya et al, 1997). Furthermore, the discussion has mainly been limited to identifying institutional and structural factors in African economies that may be inhibiting the flows of FDI. Obstacles that are typically identified in this literature include poor and deteriorating physical infrastructure, low levels of skills in domestic labour markets, corruption and crime, political instability, bureaucracy and lack of information. A possible weakness in most of the discussions on how African governments should address these obstacles is the lack of debate on the nature of Multinational Enterprises (MNEs) or Transnational corporations as agents for FDI. Instead FDI is seen as an abstract, homogenous quantity quite independently of the vehicle through which it takes place. For instance, two extensive recent surveys on FDI to Africa (see Loots, 1999; 2000) avoid any mention of MNEs in making policy recommendations. As a result of this possible weakness there is currently a relative lack of scientific understanding of the role of MNEs in African economies. A greater scientific understanding of the dynamics between MNE structure and organizational behaviour on the one hand, and African policy choice on the other, may be required to provide both the necessary and sufficient conditions for African economies to attract more FDI. The purpose of the present chapter is to analyse the results from a survey of German firms in South Africa. Apart from expanding the knowledge of MNEs in Africa, the latter survey also expands the understanding of the ge1

A version of this chapter was previously published by the University of Leipzig in its working paper series on Africa.

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ography of MNEs in general as was started by the work of Braunerhjelm and Ekholm (1998).

7.2 METHODOLOGY AND SURVEY This study made use of a structured questionnaire that was mailed to over 600 German firms in South Africa during 2000. The questionnaire is included in the Appendix. The list of firms was obtained from the Southern AfricanGerman Chamber of Commerce and Industry. 55 firms responded (10%), of which 31 questionnaires (about 5%) were satisfactorily completed. This survey was the first that required rather detailed responses from the firms on a wide range of issues from labour turnover and R&D to competitive intelligence practices and networking. However, since 1994 the Southern African-German Chamber of Commerce and Industry conducted brief annual surveys of the perceptions and opinions of German firms in South Africa. Before discussing the results from the more extended survey conducted by the authors, the recent results from the Chamber's Survey can be summarized. 7.2.1 Perceptions of German MNEs of the South African Economy Since December 1993/January 1994 Pabst has conducted a qualitative survey amongst the members of the Southern African-German Chamber of Commerce and Industry. The most recent survey was conducted in May - July 2000 (see Pabst, 2000). It is a particularly noteworthy feature of German firms' involvement in South Africa that these firms can be classified overall as medium-sized based on the fact that the vast majority employs less than 100 employees. Figure 7.1 below summarises the employment categories of German firms. It can be seen from the above than 89 out of 140 firms employs less than 100 labourers, and that 6 firms had more than 2000 employees. The survey by Pabst (2000) shows that since 1995, the majority of respondents (70%) indicated that they had not been creating any new jobs. The survey results of Pabst (2000) suggest that German MNEs in South Africa perceive labour productivity and the activities of labour unions to be an obstacle in job creation. For instance in 2000 80% of all respondents felt pessimistic and very pessimistic about the accountability of labour unions and 69% felt pessimistic and very pessimistic about the adequacy of labour productivity. In the presentation of the extended quantitative survey conducted by the authors (see below) these results are substantiated and some possible reasons for the dissatisfaction with South African labour will be identified.

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number of employees Fig. 7.1. Employment by German Firms in South Africa, 2000

The questionnaire used by Pabst (2000) contained sections dealing with economic climate, basic political structures, basic economic structures, importance of certain conditions for doing business, intentions and views with respect t o affirmative action and Black Economic Empowerment (BEE). The salient results are: 56% of firms regard the economic climate as either good or satisfactory with 14% regarding it as bad and very bad. 64% of firms are confident and very confident in the maintenance of a market driven economy in South Africa. 79% of firms expect an escalation of crime and violence. 67% of firms view labour regulations as unfair. 80% of all firms have considered or started or completed affirmative action programmes. 83% of firms are pessimistic as to whether corruption would decrease. 77% of firms have a pessimistic and very pessimistic view of the competence of the civil service. 36% consider incentives for investment not to be inadequate whilst 36% are neutral. Adequate returns on investment, maintenance of transport infrastructure and higher productivity of the labour force are cited by the majority of firms as the most important requirements whilst 98%- 100% of firms would like to see less crime and violence, better environmental protection, maintenance of educational standards, and access to international TV.

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26% of firms signified their intention to leave South Africa, with 11% considering disinvestments. Only 45% considered increasing their investment in South Africa. From the above the conclusion is that German MNEs have an important role in South Africa in terms of significant employment that is directly generated. However, it seems that these firms are experiencing severe constraints as is reflected in the high rate (almost a third) of firms considering to leave South Africa or disinvest, the negative view of the adequacy of labour and concerns over educational standards, and worries about crime, violence, corruption and the incompetence of civil servants. In the next section results from a more expansive and quantitative questionnaire based survey conducted by the authors during 2000 is set out and contrasted with some of the salient features of German firms already identified in this section. It is an aim of this paper to establish in the next section how German firms are contributing to promoting economic growth and catchingup in South Africa, and to identify what factors may be inhibiting these firms from playing a greater role in this regard. 7.2.2 Overview of German Firms in South Africa

This section provides a descriptive statistical overview of the results of the survey. Thirty-one firms in the following sectors were surveyed: transport & logistics, law, automotive components, medical, steel products, IT, construction, air transport, abrasives, textile manufacturing, metal, industrial intermediaries, precision engineering, electric actuator sales & repairs, chemical, rubber manufacturing, finance, fluid control system, haircare, consultancy, farming & transport, entertainment, mining supply & material handling, pharmaceutical-healthcare, and motor control and switch gear- manufacturing. Most firms surveyed had between 1 and 5 plants (offices) in South Africa. Table 7.1 below indicates that 96% of firms had between 1 and 5 plants (offices) and 4% had between 6 and 10 plants (offices).

Table 7.1. Number of Production Plants / Offices per German Firm in South Africa (Based on 25 Firms)

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In 88% of the cases, firms' products/services were in conformity with I S 0 requirements, as Table 7.2 makes clear.

I

I

Yes 22 88 Table 7.2. Are Your Products/Services in Conformity with International Standards Organization (ISO) Requirements? (Based on 25 Firms)

The presentation of the results are arranged in the following order, dealing respectively with labour markets and training issues, technology and R&D, investments and profits, exports, perceptions, competitive intelligence and networks and outsourcing.

7.2.3 Labour Markets and Training Over the period 1997-1999 the average number of employees per firm surveyed was 278 - indicating that most German firms in South Africa are medium to large firms. On average each firm employs 31 female labourers (i.e. just below 10%). Most female workers are employed by the smaller German firms, as ~ a b l e s7.3 and 7.4 below indicate.

51 100 101 150 151 200 More than 201

6 3 1 1

24 12 4 4

Table 7.3. Male Employees (Based on 25 Firms)

0 50 51 100 101 150 More than 150

21 1 2 1

84 4 8 4

Table 7.4. Female Employees (Based on 25 Firms)

The total wage bill per firm ranged from R 28 million to R 33 million between 1997 and 1999. In 1999 the average wage (per employee) was R29 609 (i.e. US$

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4000) per month. This is significantly higher than the average South African monthly wage. High wages is stated clearly as one of a number of measures used by German firms in South Africa to attract and maintain good employees. The survey found the following measures were part of the employee retention strategy of firms: creating a good environment, recognition, care and motivate employees and support teamwork (46%); followed by well pay (29%) and finally by means of financial bonuses or rewards (14%). More than 66% of all firms do not experience negative problems in maintaining technical expertise. Almost two-thirds (59%) of German companies regard employment equity measures as valuable. The overall majority of firms (72%) do not consider existing labour market regulations to negatively affect investment decisions. However, despite the latter finding about 53% of German firms surveyed indicated that labour market regulations do restrict further employment of local labour - a finding in line with the finding of Pabst (2000). The South African labourers employed consistent on average of 45% low skilled, 42% medium skilled, and 15% is highly skilled occupations. It was established that 69% of German firms view the existing skills in South Africa to be appropriate for South Africa's technology. However, 56% stated that training quality and skill levels in South Africa are inadequate to allow further technological transfer from abroad. Thus 66% of all questioned companies send their employees to Germany for training and expatriates play a significant role in the top management of all firms. Furthermore about 61% of all German companies provide outside/external training to suppliers or clients. In 1997, about R 0.53m was spent by German firms in South Africa on training of employees. About R 0.57m and R 0.46m was spent in 1998 and 1999, respectively. 7.2.4 Technology and Research &: Development The average expenditure made on R&D for the years 1997, 1998, and 1999 are, respectively, R0.84m, R2.6m and R1.3m. This means that between the period 1997-1998, average expenditure went up by almost 300%. Expenses, however, declined during the next period, 1998-1999, by almost 50%. Over the period 1997-1999, the average amount spent on R&D was around R1.6m. The average total expenditure on R&D, as a group, over the period 19981999 was R206 million (US$ 300 million). Total expenditure on R&D, as a group, increased by almost 17.2% from 1998 to 1999. Despite the noted increase in R&D, few news jobs have been created. Employment increased by only by 4% per annum since 1997.

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7.2.5 Investment and Profits The survey determined that the average German firm in South Africa has invested capital worth on average R 99.7 million (US$14 million) in 1999 prices. The smallest investment amounted to R34 000 while the maximum (from a MNE in the automobile sector) amounted to R 1.6 billion (US$200 million). It was found that German firms in South Africa finance investments mainly from retained earnings, parent companies, and loans sourced in Germany (30% each). Loans taken up on South African markets contribute 28% to the financing of investments. It seems that the accessibility of the financial markets represents a detriment for investing activities. Furthermore, high interest rates hamper investments to a large extent. On average $0.65m was spent on foreign licenses and agreements over the three years period. Patents have been claimed either by a small amount of number by small companies or by a large amount by very big companies. 7.2.6 Exports Marketing expenses/ budgets have increased for the last three years. Exports have increased by 155%. Surprising is the fact is that only 4% of all questioned companies are engaging in foreign trade suggesting that German MNEs are in South Africa to service the domestic market and that the country may not be seen to be attractive as a platform for international production. Transport and logistical services in South Africa is seen as having a substantial negative influence on the sales of companies. On average, German companies in South Africa spent R8.06m, R8.91m, and R9.04m on marketing in South Africa for the three consecutive years, 1997, 1998, and 1999, respectively. This shows a significant and steady increase in marketing. Most German firms in South Africa face significant competition. On average, there are 2 competitors per firm with a range of 1 and 3. In total 34 new competitors enter the market per year on average. The major destination of German trade is neighbouring countries as well as Europe and especially Germany. Other importing countries of German manufactured goods in South Africa are: Mauritius, Malaysia, England, Poland, Spain, Indonesia, Chile, Finland, Tanzania and USA. 7.2.7 Political and Business Risk Perceptions The external environment is valued as follows by German companies. Firstly, 52% of German firms in South Africa indicated that crime negatively impacts on their sales (see Table 7.5).

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1

yes

13

52

1

Table 7.5. Does Crime Impact Negatively on Your Company's Sales? (Based on 25

Firms)

Secondly, 76% of German firms indicated that corruption and theft in their own company is not a significant problem.

Table 7.6. Is Corruption and Theft a Significant Problem in Your Company?

Furthermore, more than half of all questioned firms expected the inflation, crime and exchange rate to worsen. Inflation in 3 year's time (2003) is expected to go up by about 1%. The same margin is expected for the rand-dollar exchange rate and for import tariffs. Tax rates on companies to stay the same over the next three years, 2001-2003.

7.2.8 Outsourcing and Technology Transfers About 88% of all German companies do not have a designated procurement policy. Moreover, the majority (82%) of German firms agree that there is barely any technology transfer to clients and suppliers. Outsourcing of companies' activities have become more important in German companies. Almost half of all firms questioned engage in outsourcing. Also, there has not been a significant (67%) need for restructuring the business organisation during the last years. Noticeable is the result that German companies function as information or service centres for many other African firms. Most companies (83%) maintain standardisation of certain products/services. To about 33% of all companies transportation and logistics do not seem to be a major business constraint but the same proportion states that it is an average disadvantage. Only 11% see transportation as a major issue in South Africa. Half of the operating businesses reported a profit and 20% incurred no profit and 10% encountered losses.

7 OBSTACLES FACING GERMAN ENTERPRISES

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7.2.9 Conclusions In a context of increasing globalisation Africa requires investment by multinational enterprises (MNEs) to improve its competitiveness and to facilitate micro-level structural changes required to reduce is riskiness as an investment environment. Hence, Africa might be in low-growth equilibrium trap, unless factors and conditions can be identified whereby MNEs can become more involved in African economies. To therefore broaden the understanding of the role of MNEs in Africa's economic performance, a study was undertaken of German MNEs in South Africa during 2000. The study made use of a structured questionnaire that was mailed to over 600 German firms in South Africa. The list of firms was obtained from the Southern African-German Chamber of Commerce and Industry. About 55 firms responded (10%), of which 31 questionnaires (about 5%) were satisfactorily completed. This survey was the first that required rather detailed responses from the firms on a wide range of issues from labour turnover and R&D to competitive intelligence practices and networking. However, since 1994 the Southern African-German Chamber of Commerce and Industry conducted brief annual surveys of the perceptions and opinions of German firms in South Africa. From the analysis of the findings of this qualitative survey of the Southern African-German Chamber of Commerce and Industry it was concluded in this chapter that German MNEs have an important role in South Africa in terms of significant employment that is directly generated. However, it seems that these firms are experiencing severe constraints as is reflected in the high rate (almost a third) of firms considering to leave South Africa or disinvest, the negative view of the adequacy of labour and concerns over educational standards, and worries about crime, violence, corruption and the incompetence of civil servants. From the own survey conducted in 2000 it was found that the position of German MNEs in South Africa is tenuous. Not many companies engage in exporting and it seems the reason for German MNE presence in South Africa is to serve the domestic market. In the latter regard their constraints seem to reside in the labour market and uncertain macro-economic environment. As such German MNEs have not been creating significant new job opportunities, despite increasing investments in R&D activities advancements in technology. A lack of skills and concern about educational standard were espressed by firms and most prefer to train their workers in Germany. Investment by German firms in SA (with notable single exceptions) seems to be stagnating (despite rising profits) and most firms see a worsening of crime, inflation and expect further depreciation of the Rand.

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REFERENCES Bhattacharya, A., Montiel, P.J., Sharma, S. (1997). Can Sub-Saharan Africa Attract Private Capital Inflows? Finance and Development, Vol. 34, No. 2: 3-6. Braunerhjelm, P., Ekholm, K. eds. (1998). The Geography of Multinational Firms. Dordrecht: Kluwer Academic Publishers. Cassim, R. (2000). Some Notes on Foreign Direct Investment in South Africa, Trade and Industry Monitor, 15: 12-15. Coetzee, Z.R., Gwarada, K., Naude, W.A., Swanepoel, J. (1997). Currency Depreciation, Trade Liberalisation and Economic Development, South African Journal of Economics, 65(2): 165-190. Collier, P., Gunning, J.W. (1999). Explaining African Economic Performance Journal of Economic Literature, Vol. 37, No. 1: 64-111. Collier, P., Hoefner, A., Patillo, C. (1999). Flight Capital as Portfolio Choice, World Bank Policy Research Paper 2066, Washington DC. Easterly, W., Levine, R. (1997). Africa's growth tragedy: policies and ethnic divisions. Quarterly Journal of Economics, 112, Nov: 1203-1250. Francios, J.F., Nelson, D. (1998). Trade, Technology, and Wages: General Equilibrium Mechanics, Economic Journal, 108: 1483-1499. GEAR (1996). Growth, Employment and Redistribution. A Macro-Economic Strategy, Department of Finance, Pretoria. Greenaway, D. (1998). Policy Forum : Trade and Labour Market Adjustment: Editorial Note, Economic Journal, 108: 1450-1451. Gries, T., Naude, W.A. (2001). On Global Economic Growth and the Challenge Facing Africa, unpublished paper, Department of Economics, University of Paderborn, Germany (see also chapter one of this volume). Heese, K. (1999). Foreign Direct Investment in South Africa (1994-1999) Confronting Globalisation, Paper presented at the 1999 Annual TIPS Forum at Glenburg Lodge, 19-22 September. Hirsch, A. (1994). GATT: The Way Forward, Indicator SA, 12(1): 43-48. IDC (1995). SA's Final Tariff Schedule, Internal Working Document, IDC, Sandton, 4 Dec.

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Lall, S. (1998). Changing Perceptions of Foreign Direct Investment (In: Tharakan, P.K.M., Van der Bulcke, D. eds. International Trade, Foreign Direct Investment and the Economic Environment. London: MacMillan.) Loots, E. (1999). Some New Evidence on Foreign Direct Investment Flows to Developing Countries: Policy Implications for South Africa, Paper presented at the Bi-ennial Conference of the Economic Society of South Africa, Pretoria, 5-6 September. Loots, E. (2000). Foreign Direct Investment Flows to African Countries, Research Paper no. 0011, Department of Economics, Rand Afrikaans University. Maechler, A.M., Roland-Hoist, D. (1997). Labor Market Structure and Conduct, (In: Francios, J.F., Reinert, K.A. eds. Applied Methods for Trade Policy Analysis : A Handbook. Cambridge: Cambridge University Press.) OECD (1996). OECD Benchmark Definition of Foreign Direct Investment, Paris: OECD. Pabst, G. (2000). Sixth Survey of German Enterprises in South Africa: Views, Opinions, Judgements, Intentions and Considerations with Regard to Policy and Economy, Southern African-German Chamber of Commerce and Industry, Houghton, South Africa. Sachs, J.D., Warner, M. (1995). Economic Reform and the Process of Global Integration, Journal of African Economies, 6: 335-376. Slaughter, M.J. (1998). International Trade and Labour-Market Outcomes Results, Questions, and Policy Options, Economic Journal, 108:1452-1462. Teal, F. (1999). Why can Mauritius Export Manufactures and Ghana not? Working Paper 99/10, Centre for the Study of African Economies, University of Oxford. UNCTAD (1999). Foreign Portfolio Investment and Foreign Direct Investment: Characteristics, Complementarities, Differences and Policy. Expert Meeting on Portfolio Investment Flows and Foreign Direct Investment. Geneva, 28-30 June. Wood, A. (1998). Globalisation and the Rise in Labour Market Inequalities, Economic Journal, 108: 1463-1482.

8

COMPETITIVE INTELLIGENCE IN A FOREIGN ENVIRONMENT: GERMAN AND CANADIAN FIRMS COMPARED J. CALOF1 and W. VIVIERS2 1 2

University of Ottawa, Canada North-West University, South Africa

8.1 INTRODUCTION Determining what is going to happen next in your environment and then taking advantage of it is critical to any company or government. Knowing what customers truly want and staying ahead of the competition is crucial to business success. This is competitive intelligence. Competitive Intelligence is becoming more recognized as a discipline all around the world. Organized programs can be seen in virtually every developed country and governments around the world are focusing more resources towards it (Calof and Viviers, 2001). Competitive Intelligence and its sister field of Knowledge Management are growing at impressive rates throughout North America, Europe and Asia. Membership in the Society of Competitive Intelligence Professionals (SCIP) grew at an annual rate of 40 percent in the 1990's reaching 7000 members in 2000 and academic programs have been developed throughout Europe, North America and recently in China. How important is competitive intelligence becoming? Consider the following quotes, one by Bill Gates, President of Microsoft, John Pepper, Chairman of Procter and Gamble: "The most meaningful way to differentiate your company from your competition, the best way to put distance between you and the crowd, is to do an outstanding job with information. How you gather, manager, and use information will determine whether you win or lose". (Gates, 1999) "I can't imagine a more appropriate time to be talking about competitive intelligence than right now, for I can't imagine a time in history when the competencies, the skills, and the knowledge of the men

210

J. CALOF and W. VIVIERS and women in, or, as I'll be calling it, business intelligence, are more needed and more relevant to a company being able to design a winning strategy and act on it". (Pepper, 1999)

8.2 THE PROCESS OF INTELLIGENCE At a simplistic level, competitive intelligence (CI) can be defined as information that makes the firm more competitive. One of the better definitions comes from the Business Intelligence Institute in the United States: "Competitive/Business intelligence is the total knowledge a company possesses about the environment in which it competes. It is synthesized from the vast amount of bits and pieces of external information bombarding the firm every day. It paints a whole picture of the present and future competitive arena of management decisions." (Gilad, 2000) The fuller definition is: "Competitive intelligence is the art and science of preparing companies for the future by way of a systematic knowledge management process. It is creating knowledge from openly available information by use of a systematic process involving planning, collection, analysis, communication and management, which results in decision-maker action." (Calof and Skinner, 1999) Whatever definitions is chosen, all point towards creating knowledge from openly available information by use of a systematic process involving planning, collection, analysis, communication and management, which results in decision-maker action. The intent of CI is to better understand customers, regulators, competitors, and so forth to create new opportunities. In fact, the intent is to forecast changes in any of these forces and better position the firm to take advantage of these changes. When people talk about competitive intelligence there tends to be confusion between competitive intelligence, spying/espionage and knowledge management. According to Patrick Bryant, the President of SCIP (Society of Competitive Intelligence Professionals), "Espionage is the use of illegal means to gather information. On the other hand, CI is the process of gathering data using legal, ethical means and turning it into valuable intelligence through careful analysis" (SCIP, 2001). Competitive intelligence therefore differs from spying in that is uses legal means and goes well beyond data collection. Differentiating between competitive intelligence and knowledge management is more difficult as there are many different definitions of knowledge management. Most authors in the field define knowledge management in terms of

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211

gathering and storing the collected knowledge of the organization. For example, Phios corporation defines it as "knowledge repositories". These repositories can be used to organize document, a "best practice library, measurement and benchmarking data and links to relevant web sites". A definition from Simmons College in the United States provides a useful comparison: •

Competitive Intelligence tends to involve gathering information about the outside environment in order to plan for the future of your own company and products/ services. • Knowledge Management tends to focus on the identification and integration of existing knowledge within your own people and organization as well as the outside world, and sharing and using that effectively to improve what you do. These definitions suggest that while the competitive intelligence incorporates knowledge management processes of collecting and storing information, competitive intelligence definitions also talk more about the actual analysis of the data - a process that knowledge management definitions rarely mention. While there are various definitions, the easiest way to conceptualize the difference is to define knowledge management as the capturing, filing and categorization of the information and competitive intelligence as the focusing, analyzing and actioning of the data. Without knowledge management you could not do competitive intelligence as CI requires access to information. However, without CI, knowledge management becomes a fruitless exercise of filing and categorizing information. It is more useful to combine the two concepts and call it Business Intelligence for Knowledge Management (BIKM). The concept of intelligence as a process has long been proposed as an effort to increase the firm's competitiveness and its strategic planning process (Guyton 1962; Pearce 1976, and Montgomery and Weinberg 1979, Porter 1980). In 1966 William Fair proposed the formation of a corporate "Central Intelligence Agency" within the firm whose function it would be to "collect, screen, collate, organize, record, retrieve and disseminate information". Since that time, this proposition as grown to become an emerging business construct with delineated job functions directly responsible for intelligence collection, analysis, and dissemination (Kahaner 1996). From previous studies there appear to be clear and distinct stages in the CI process. Key areas that appear to emerge in the literature are: 1. Planning and focus—CI is not about collecting all information or researching everything, but focusing on those issues of highest importance to senior management. This phase is required to set required resources for the CI project or process as well as to establish the purpose and result of the findings. It is during this phase in which the assessment of

212

2.

3.

4.

5.

6.

J. CALOF and W. VIVIERS what intelligence is required for the managerial decision which is under uncertainty (Herring, 1998). Collection—It is during this phase that information is collected from a variety of sources for examination during the CI process. Collection comes from a variety of different sources and acquisition methods including environmental scanning with the literature focusing on the use of primary source information (interviews with industry experts) (Aquilar, 1967). Analysis—Many practitioners believe that this is where "true" intelligence is created, that is converting information into "actionable intelligence" on which strategic and tactical decision may be made (Gilad and Glad 1986, Kahaner 1996, Calof and Miller 1996, Herring 1998). Communication—The results of the CI process or project needs to be communicated to those with the authority and responsibility to act on the findings (Kahaner, 1996). Process/structure—CI requires appropriate policies, procedures, and a formal or informal infrastructure so that employees contribute effectively to the CI system as well as gain the benefits from the CI process. There is much support for a formal structure and a systematic approach to CI (Cox and Good 1967, Porter 1980, Gilad and Gilad 1985, 1986, Ghoshal and Kim 1986). However, many firms' CI efforts are short-term projects and do not have on-going CI processes in place, but still conduct CI activities (Prescott and Smith 1989). Organizational Awareness/Culture—For a firm to utilize its CI efforts successfully, there needs to be an appropriate organizational awareness of CI and a culture of competitiveness. Wall in 1974 proposed that a firm must have and internal sense of competitiveness in order to gain the maximum effectiveness of an intelligence department. There has been support for this awareness/culture construct in the area of market orientation (Ghoshal and Wesney 1991, Ghoshal and Kim 1986).

8.3 THE SURVEY - THE QUESTIONNAIRE The objective in this chapter is to report on the results of a survey conducted on German MNE's operating in South Africa and contrast these results with studies conducted on Canadian and U.S. companies. Companies in these studies were asked several questions designed to identify their intelligence practices. In particular, the questionnaire examined how they conducted the intelligence process, the extent to which various information sources were used, and the problems they encountered in their intelligence efforts. These questions were modelled after those used in past studies by Calof (1996) and Calof and Viviers (2002). The results of the German firms are then contrasted to those obtained in intelligence studies conducted on Canadian and U.S. firms.

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The Canadian Study 1 - Calof and Breakspear (1999) A version of the Sawka, Prances and Herring (1996) survey and the U.S.based Industrial Research Institute (IRI) and Society of Competitive Intelligence Professionals (SCIP) who administered it to IRI-member companies in the United States was used to examine the intelligence practice of Canadian technology firms. In all, a census of 3,080 firms was identified. Questionnaires were sent to all 3,080. Of the 3,080 surveys sent out, 1,280 were returned. Two hundred and fifty-five were eliminated for a variety of reasons. In all 1,025 completed surveys were used in this study, for a valid response rate of just over 33%. In this paper, this study is referred to as Calof and Breakspear, 1999. The results of this survey are used to contrast the German results dealing with formality of the intelligence structure. The Canadian Study 2 (Calof, 1996) In answer to the question of what information should the Canadian government provide Canadian exporters, a market information and intelligence task force was struck in 1993. As part of its work, this group commissioned a study which examined the international information practices and needs of Canadian exporters. To that end, they created a comprehensive questionnaire, pre-tested it, and had qualified officers with appropriate training administer the questionnaire to a selected group of Canadian firms. A stratified, non random selection of 150 firms was developed to ensure the appropriate mix of company sizes, industry sectors (at least three companies were needed from the 17 selected sectors), and geographic area (representation of all of Canada's provinces). An additional 100 firms were added for other diverse reasons. The responses from these firms were supplemented by interviews conducted by the author with senior executives from 48 medium sized Canadian exporting firms. Of the 250 firms approached for the survey portion of the study, 237 agreed to participate in the interviews. Of these, 209 were actual exporters. Thus, over 90% of the firms approached for this study agreed to participate. This study is referred to in this chapter as Calof 1996 and is the basis for the comparative data on the information used in the intelligence process. The Canadian and U.S. Study (Calof and Miller, 1996) In 1995, the Society of Competitive Intelligence Professionals (SCIP), undertook to examine the intelligence practices of its' member firms. The objective of the study was to examine how intelligence was being practiced and the problem firms were encountering. The survey was sent to SCIP chapter chairs for distribution at SCIP meetings and was also placed on the SCIP web page. Through these methods, the questionnaire was administered as broadly as possible. In all, 250 questionnaires were received from a broad range of com-

214

J. CALOF and W. VIVIERS

panies dominantly located in Canada and the U.S. The results of this study is used to contrast results of various process elements and problems encountered with the German MNE study. German Firms in South Africa According to the South African - German Chamber of Commerce (SAGCC) there are around 560 German firms employing roughly 65 000 people active in South Africa. Most of these enterprises are in the secondary sector. Giitschleg (1999) identifies the machinery, electronic, chemical, pharmaceutical, automobile, and metal production sectors as the major hosts for German firms respectively. Gutschleg (1999:81) states that the average German firm has been operating in South Africa for 22 years. The major industrial areas of South Africa can be found in the Pretoria-Witwatersrand-Vereeniging (PWV) region, the Durban-Pinetown region, the Port Elizabeth-Uitenhage region, East London and the Cape peninsula. Of all German companies Gutschleg (1999:91) identified 89 percent in the Gauteng region, six percent in the Eastern Cape, four percent in the Western Cape and only one percent in Kwazulu-Natal. Thus, German firms tend to follow the presence of local agglomeration advantages and economies of scale. In terms of management, the implementation of German management appears to be prevailing in every company. Mundorf (1993:218) sees a trend of German companies to engage in collaborations, strategic alliances or in a takeover of management by purchasing the majority of shares. Further, he noticed that nearly all German subsidiaries strive for the majority of shares in order to control, coordinate and exert own commercial activities and decisions. The main reasons for German firms to have entered South Africa is due to their internationalisation strategy, the strive for increasing international division of labour, the financial interconnection, the securing of markets and the surmounting of trade restrictive barriers. Factor, transport, and production costs, the political situation together with investment incentives, infrastructure and natural resources seem to be of a second priority for investment decisions (Mundorf, 1993). South African firms expect a higher intensity of competition due to the opening up of the economy in comparison with German firms. Naturally, German firms know the European market quite well and are familiar with its export patterns. Thus, German firms are in competition with imports from EU and other foreign companies in South Africa. In particular, there is a fierce competition from South-East Asian countries experienced in South Africa by German firms. By sectors Gutschleg (1999:138) found, for example, that German automobile companies do not consider themselves to be competitive without tariff protection in South Africa. This might be reason to the diminishing local content programmes which have been reduced since its introduction in 1961 in order to support South Africa's automobile

8 COMPETITIVE INTELLIGENCE

215

industry. Generally, firms with production facilities fear anti-dumping cases. On the other hand, it is possible that MNEs without a production facility may undercut prices and sell their corporate production surplus at variable cost prices. The automobile production and its supply industry had to face reducing profitability and turnovers as protecting tariff duties have been abolished and new competition appeared on the market. In contrast Giitschleg (1999:202) noticed that German companies in the field of construction, engineering and metal processing have improved their economic situation considerably. In particular he found that German and South African corporations perceive themselves to be internationally competitive enough to be successful in the near future (1999:144).

8.4 METHODOLOGY The study made use of a structured questionnaire that was mailed to over 600 German firms in South Africa. The list of firms was obtained from the Southern African-German Chamber of Commerce and Industry. About 55 firms responded (10%), of which 31 questionnaires (about 5%) were satisfactorily completed. The relatively small sample size make it difficult to generalise the results and also precluded econometric analysis. This survey was the first that required rather detailed responses from the firms on a wide range of issues from labour turnover and R&D to competitive intelligence practices and networking. In this paper, the focus will be on the innovation, R&D and technological spill-over effects (or potential therefore). General Overview Table 8.1 below shows that motor vehicles, metal products and chemicals are the sectors in which German firms more active in South Africa. As it may be seen from Table 8.3, in each of the groups of industries the "larger" firms - employing more than 200 persons - have got the highest percentage of employees. But if the "large" firms - employing more than 500 persons - are disregarded, it becomes obvious, that the medium-sized firms that employ more than 20, but less than 500 persons, had higher percentages of employees in each group of industries. In relation to all employees of the firms with less than 500 persons the largest percentages of employees of the sample concerned the firms employing 100 - 199 persons (41,6%) and the firms employing 200 - 499 persons (33,8%). Even the firms with 20 - 99 employees had a considerable quota of persons under labour contract (20,6%).

216

J. CALOF and W. VIVIERS Sector

Number Sak'j, oi ririns total (Mio. R.)

per firm (Mio.K.)

132

33

total

per tirin

Motor vehicles Metal products

4 6

7.095

1.183

271 6.125

68 1.021

Chemicals & rubber manuf.

5

94

19

375

71

Pharmaceuticals

3

110

37

257

86

Electronics Construction & Textiles Transport Finance a.o. services

4 2

52 170

13 85

190 220

48 110

3 4

709 274

236 69

302 354

101 89

31

8.636

279

8.094

261

Total

T a b l e 8 . 1 . Firms, Sales and Employees of German Firms in South Africa 1999 Sector

Firms vti h... vmp lo> cvs

Number of 1 iritis

Motor Vehicles Metal Products Chemicals & rubber manuf. Pharmaceuticals Electronics Construction & Textiles Transport Finance a.o. services Total

4

1-9 10-19 20- 100-199 200 a.m. Total 99 271 126 145

6

o

5

9

95

115

5.906

6.125

21 345

375 257

3

15

57 185

4 2

3 19

48 120 20

200

190 220

3 4

3 19 10

84

280 260

302 354

31

34 53

6.646

8.094

451 910

T a b l e 8.2. Sample of German Firms in South Africa According to Industries and Firm-Size (Employees) 1999

8 COMPETITIVE INTELLIGENCE

217

100-199 200 a.m. Total Manufacturing industries1' Construction & textiles Transport, finance a.o. services

22

Total

31

71,0

0,3 0,5

6,4 22,6

2,0 2,9

100,0 0,4 0,7

4,8

81,8

100,0

9,9

90,1

100,0

12,8

82,3

100,0

82,1

100,0

5,6

12,6

11,2

Table 8.3. Percentages of German Firms According to Groups of Industries and Firm-Size (Number of Employees) 1999

Most firms surveyed had between 1 and 5 plants (offices) in South Africa. About 96% of firms had between 1 and 5 plants (offices) and 4% had between 6 and 10 plants (offices). In 88% of the cases, firms' products/services were in conformity with ISO requirements. German firms in South Africa behave roughly in accordance with the traditional textbook model of MNEs / FDI. For instance they tend to produce mainly for the domestic market (i.e. their investment decision is not based on using South Africa as a competitive platform for exporting) and as will be shown they pay higher wages that local companies and operate very much within "enclaves" from the local economy- although there are exceptions. For instance, the focus on the domestic market is clear from considering that marketing expenses/ budgets have increased for the last three years. Bearing in mind sample problems, only 4% of all questioned companies are engaging in foreign trade suggesting that German MNEs are in South Africa to service the domestic market and that the country may not be seen to be attractive as a platform for international production. Transport and logistical services in South Africa is seen as having a substantial negative influence on the sales of companies. However, despite this exports have increased by 155% over the past three years indicating the domestic market pressures may be forcing these firms to find other outlets as well3. 3

The major destination of German trade are neighbouring countries as well as Europe and especially Germany. Other importing countries of German manufactured

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J. CALOF and W. VIVIERS

On average, German companies in South Africa spent R8.06m, R8.91m, and R9.04m on marketing in South Africa for the three consecutive years, 1997, 1998, and 1999, respectively. This shows a significant and steady increase in marketing. Most German firms in South Africa face significant competition. On average, there are 2 competitors per firm with a range of 1 and 3. In total 34 new competitors enter the market per year on average. Prior to reporting on the results of the German MNE study and contrasting these with Calof and Breakspear (1999), Calof (1996) and Calof and Miller (1996) a few limitations of the comparisons are discussed. 1) Within the German MNE study for most intelligence questionnaires, responses were recorded from fewer than 40 firms and as was the case for a few of the variables 29 responses were recorded (from a total of 60 firms), making generalization of the results very difficult. The low response rate on intelligence questions (under 50%) may be indicative of lower level intelligence practices, lack of comprehension of the questions or simply a lengthy questionnaire. This should be investigated in a future study. 2) A direct comparison between the German results and Canadian/U.S. results are difficult as there were several differences in the questionnaire. Each version of the intelligence studies improves on the questions asked in the previous survey. Thus, direct comparisons are done where the questions are somewhat similar. 3) Direct comparisons are also difficult to make due to the different time frame of the studies. The two Canadian studies cited in this chapter were conducted in 1991 and again in 1996, while the German study was conducted in 1999. 4) The firms in the studies are different in terms of size and sector. For example, the Calof and Breakspear (1999) study was dominated by smaller firms (91 employees) coming from the technology sector, the Calof (1996) study had firms from a broad cross-section of industries and averaged 857 employees, the Calof and Miller study also came from a broad cross-section of industries but had on average 15,672 employees. While size is not a barrier to competitive intelligence practices it is correlated with formality of the intelligence process (Calof and Breakspear, 1999).

goods in South Africa are: Mauritius, Malaysia, England, Poland, Spain, Indonesia, Chile, Finland, Tanzania and USA.

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8.5 SURVEY RESULTS Competitive Intelligence Structure Respondents from the German company survey had been conducting competitive intelligence for on average 10.2 years. Firm's indicated that they did have a formal intelligence program (75%) with 21% indicating that they had a formal competitive intelligence unit. The remaining firms tended to place responsibility for competitive intelligence activities in either marketing (46%) or strategy/corporate level (24%). When asked about how they resourced the intelligence function respondents had 3.7 full time employees and 6.9 part time employees. This is indicative of a more formal intelligence program. How does this compare to Canadian intelligence programs? The following indicates how respondents in the Calof and Breakspear study (1999) responded when asked what best described how they are organized for conducting intelligence: • • • • • • •

Scattered/disorganized (2%) One part time person (23%) Several part time personnel (47%) One full time person (3%) Several full time personnel (2%) CI unit (3%) Integrated throughout the organization (20%)

When asked if they have a formal system, only 11% said yes. These results suggest that the Canadian model of Cl is currently a part time one. However, the Calof and Miller study (1996) is somewhat more consistent with the German results? The following indicates how responded when asked what best described how they are organized for conducting intelligence: 1. 2. 3. 4. 5.

One staff member designated part-time to conduct intelligence (18.1%) One staff member designated full-time to conduct intelligence (14.8%) A few staff members conducting intelligence (21.8%) A separate intelligence department established (19.9) Intelligence function integrated throughout the organization (11.6%) Other (13.9%)

Within this U.S. and Canada study, the CI process averaged 6 years - 4 years less than the German results.

220

J. CALOF and W. VIVIERS

These comparisons indicate that the German CI programs tend to have been around longer than the Canadian and U.S. intelligence programs and more formal in orientation. Method of Conducting Competitive

Intelligence

The literature review section described the intelligence project process by breaking it down into five distinct functions - planning, collecting, analysis, communications and management. In the literature review section, To contrast the intelligence process of the German, Canadian and U.S. firms respondents in all studies were asked to estimate the percentage of intelligence time spent on the various intelligence functions. The results of these are presented in table 8.4. The results indicate that there is very little difference in the breakdown of the intelligence process in terms of functions. Minor variances were evident in areas such as collection with Canadians spending more times in the collection process than German and American and U.S. firms spending more time on both Analysis and Dissemination than their Canadian or German counterparts but the order of magnitude of these differences (all under 10%) were insufficient to conclude that there were massive process differences between Canadian, American or German CI practices. Area Planning Collecting Analyzing

German Firms Canadian Firms £L& Firms 12.8 12.1 12.8 35.3 38.1 29.3 23.1 28 31.4

15 12.1 9.8 Table 8.4. Percentage Breakdown Time Spent on Intelligence Functions Disseminating

13.7

Evaluating

15.1

Information

11.3

Sources

Where do companies get their information from in the intelligence process? Both the Calof study (1996) and this one focused on understanding where executives went to get information. Respondents in both studies were asked to rate a variety of sources on a four point likhert scale ranging from 0 (not important) to 3 (very important). The results are presented in tables 8.2 and 8.3. Direct comparisons are difficult for this question as different information sources were presented in both surveys. However, what is evident in contrasting results where similar sources are presented are that both the German and Canadian firms put a higher value on primary sources (people) than secondary sources (archived). This is consistent with good intelligence practices.

8 COMPETITIVE INTELLIGENCE

illiiiiiillllillli

Results

Associations

2.2

Subordinates

2.2

Focus groups Archival

2.7|

0.9

Competitors

2

Consultants

1.4

Customers

2.3

Government Your

0.7

Government Foreign

0.4

Internet Journalists

1.7| 0.7|

Personnel other dept.

1.8|

Personnel your dept Superiors

1.9| 2.3

Suppliers

2.4

Table 8.5. Information Source Importance for German MNE's

liliiillBllllIIIll lilliiii'ill 2.5 Associates Personal contact overseas Foreign clients Canadian embassy Trade Fair Published sources Multi National Enterprise Partners

2.5! 2.4 1.9 1.8: 1.7i

Foreign Affairs (Ottawa) Associations Provincial Agency International Trade Center Other Government Department Industry Canada Computer Databases Foreign Post in Canada Technical societies Foreign consultants Canadian consultants Banks University U.S. Consultants Library

1.5!

1.6:

1.4 1.3 1.3 1.2 1.1 1.1 1.0'

1.0 .9 .9 .9 .8 .8 .6

Table 8.6. Information Source Importance of Canadian Exporters

221

222

J. CALOF and W. VIVIERS

The Canadian firms, where however, more likely to use Government sources (1.9) than were the Germans (.7) while the Germans were more likely to use Associations (2.2) than the Canadians (1.4). These results could point to a more developed government information structure in Canada and a greater presence of industry associations in Germany. Regardless of the explanation it is apparent that there are differences in the information acquisition behaviours of Canadian and German firms that should be investigated in future studies. Where do you go for your international information needs? Please grade according to their importance and use using the following scale: 0 = no use to 3 highly used.

The Extent to Which Some Problems Hamper Intelligence Efforts The final portion of the German MNE CI study looked at problems hampering the intelligence effort. In all, 14 barriers that have been identified in the CI literature were investigated. Of these, nine were also asked in the Calof and Miller study (1996). Participants were asked to assess the barriers on a four-point likhert scale ranging from 0 (no problem) to 3 (major problem). In contrast to previous results in this comparative paper, there were dramatic differences between the Canadian, U.S. and German firms. In virtually every barrier area there were major differences between the groups. For example, top management support was a very minor barrier within the German firms (8.3 - 8.4) but more significant with the Canadian and American companies (2.2 and 1.3); getting people to share information was also much more a significant problem as was integrating information and getting management to use the output. In eight of the nine common barrier areas, U.S. and Canadian firms indicated greater barriers than the German MNE's. It was only in the Feedback area that German firms indicated a more major barrier but by a very narrow margin (1.7 versus 1.5).

8.6 CONCLUSIONS The objective of this chapter was to examine the intelligence practices of German MNE's and contrast these to those found in Canadian and U.S. studies. Taking into consideration the caveats involved in the comparison of these results (different size firms, different sectors and different time frame between all the comparative studies), the results indicate that German CI efforts are slightly more advanced in terms of formality when contrasted to both Canadian and American firms, have been around for a longer length of time and suffer from far less problems. However, in terms of the actual process of conducting intelligence projects, few differences are evident. Canadian's and Germans make similar use of primary information sources, seem to spend a similar

8 COMPETITIVE INTELLIGENCE German study

Calofand Witter

American Companies

Canadian Companies

0.3

1.2

1.3

2.2

1

2

1.7

1.6

Getting people to Share information

1.3

2.2

1.8

1.8

Number ofCI personnel

0.9

1.8

1.6

1.1

Internal politics

0.5 0.8

1.6

1.4

2.3 1.8

Barrtet Top Management support Legal issues

0.6

Ethical issues Integrating CI in the organization

0.9

Getting management to use CI output Credibility ofCI with mangement

0.4

1.5

1.2

Feedback on CI projects Budget Training

1.7 1.1 1.2

1.5

1.4

1.6

1.3

1.5

Counter-intelligence

1.1

1.3

1.1

0.6

223

Table 8.7. Barriers in the Intelligence Process

percentage of time in the different functions of intelligence (planning, collection, analyses, communications, and management).

224

J. CALOF and W. VIVIERS

REFERENCES Aguilar, F.J. (1967). Scanning the Business environment, New York: MacMillan. Calof, J.L. (1996). So you want to go international? What information do you need and where will you get it? Competitive Intelligence Review, Winter. Calof, J.L. (2001). The Competitive Intelligence audit guide. SCIP conference, 2001. Calof, J.L., Breakspear, A. (1999). Competitive intelligence practices of Canadian Technology Firms. National Research Council/Canadian Institute of Scientific and Technical Information. Calof, J.L., Miller, J. (1996). Survey of SCIP members intelligence practices. Proceedings of the Society of Competitive Intelligence Professionals, Annual Meeting. Washington, DC. Calof, J.L., Skinner, B. (1999). Creating an Intelligence Society: The Role of Government in Competitive Intelligence. What's Happening In Canada? Competitive Intelligence Manager, Spring. Calof, J.L., Viviers, W. (2001). Adding Competitive Intelligence to South Africa's Knowledge Management Mix, Africa Insight, (31)2, June: 61-67. Calof, J.L, Viviers, W. (2002). International information seeking behaviours of South African exporters. South African Journal of Information Management, 4(3), Sept. Online: www.rauac.za/sajim Cox, D.F, Good, R.E. (1967). How to build a marketing information system. Harvard Business Review, May/June: 145-154. Ghoshal, S., Kim, S.K. (1986). Building effective competitive intelligence systems for competitive advantage. Sloan Management Review, 28(1): 49-58. Ghoshal, S., Wesney, D.E. (1991). Organizing competitor analysis systems. Strategic Management Journal, 12(1): 1-15. Gilad, B. (2000). Making the Case for Business Intelligence, Proceedings of the Society of Competitive Intelligence Professionals, Atlanta, Georgia, USA, April. Gilad, B., Gilad, T. (1985). A systems approach to business intelligence. Business Horizons, 28(5): 65-70.

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Gilad, T., Gilad, B. (1986). Business intelligence - the quiet revolution. Sloan Management Review, 27(4): 53-60. Giitschleg, D. (1999). Deutsche Unternehmen im neuen Siidafrika, Berlin: Deutscher Industrie- und Handelstag. Guyton, W.J. (1962). A guide to gathering marketing intelligence. Industrial Marketing, March: 84-88. Herring, J. (1998). What is intelligence analysis? Competitive Intelligence Magazine, 1(2): 13-16. Kahaner, L. (1996). Competitive Intelligence. How to gather, analyse and use information to move your business to the top, Is* ed, Simon & Schuster: New York. NY. Montgomery, D.B., Weinberg, C.B. (1979). Toward strategic intelligence systems. Journal of Marketing, 43: 41-52. Mundorf, D. (1993). Bedeutung von Investitionen deutscher Industrieunternehmen fur die Wirtschaft Siidafrikas, Europaische Hochschulschriften, 1361:, Frankfurt am Main: Peter-Lang Verlag. Pearce, F.T. (1976). Business intelligence systems: the need, development and integration. Industrial Marketing Management. Pepper, J.E. (1999). Competitive Intelligence at Proctor and Gamble. Competitive Intelligence Review, 10(4): 4. Porter, M.E. (1980). Competitive Strategy: Techniques of Analyzing Industries and Competitors. The Free Press: New York NY. Prescott, J., Smith, D. (1989). The largest survey of leading edge competitor intelligence managers. Planning Review, May/June: 6. Sawka, K.A., Francis, D.B., Herring J.P. (1996). Evaluating business intelligence systems: How does your company rate? Competitive Intelligence Review, 10t'1 Anniversary Edition. SCIP (2001). Society for Competitive Intelligence Professionals, www.scip.org

Part III

Labour Market Adjustment, Foreign Direct Investment and Human Resource Development

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT: A Theoretical Analysis with Heterogeneous Labour T. GRIES1 and S. JUNGBLUT2 1 2

University of Paderborn, Germany Thomas.Gries9notes.uni-paderborn.de University of Paderborn, Germany jungblut9notes.uni-paderborn.de

9.1 INTRODUCTION High unemployment rates in South Africa's labour market of approximately one third of the labour force will be the most challenging problem in the next decade. Not only the level of unemployment is intolerable, also the structure is alarming. In the last two decades the gaps in unemployment rates and/or wages of unskilled and skilled labour has increased in almost all developing countries [OECD (1997), Gottschalk/Smeeding (1997), Murphy/Topel (1997)]. Further, as Whiteford/Seventer (2000) point out, in South Africa unemployment is also the major reason for poverty and for high inequality in income distribution.3 High unemployment rates may also become an obstacle for growth, as social unrest and political instability becomes more likely. Without a significant increase in employment, economic and political stability will be hard to obtain. As the problem of unemployment and low or even decreasing wages is likely to strike more unskilled labour [see e.g. Hofmeyr (2000)] most political concern should be devoted to this group of the labour force [see GEAR (1996)]. Both increasing trade and biased technological progress are blamed to cause inequality in labour markets. Empirically, this debate is still open. While OECD (1997) or Cline (1997 Ch.2) conclude that globalisation is of minor importance Wood (1998) summarises "...I review and reappraise the evidence, suggesting that most of it is, in fact, consistent with the hypothesis that the main cause of the rise in labour market inequalities is globalisation." [Wood (1998 p. 1468)]. For South Africa evidence seems to be mixed. Bell/Cattaneo (1997) or Edwards (1999) argue that a labour biased shift in trade affected employment in manufacturing industry negatively. Edwards (2000) not only 3

See also the other contributions in Leibbrandt/Nattrass (2000) "South Africa's changing income distribution in the 1990s"

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T. GRIES and S. JUNGBLUT

analysed the impact of trade on the level of employment, but also breaks down the occupational employment impact. While in his findings the dominant source of employment change was technology, manufacturing is characterised by a skill bias in net trade reducing elementary employment. A number of approaches are used to model the effects of trade liberalisation on labour market performance.4 Especially unskilled labour does not always seem to realise a positive impact from trade liberalisation. The impact of globalisation on domestic labour markets goes well beyond its linkage with trade. A second channel is opened by factor mobility. Especially capital mobility and FDIs play a major role. There is hope that inflowing capital will create additional jobs and therefore will have positive employment effects. "Areas of economic activity previously closed to foreign enterprises are now being opened up and strong efforts are being made to woo TNCs." [Lall (1995 p.521)]. It seems also evident that FDIs will have positive effects on employment on total, but the structure of these effects is not so clear. "Despite the obvious importance of TNCs in creating employment opportunities in host countries the exact links between FDIs and labour markets are difficult to trace quantitatively" [Lall (1995 p.522)]. What happens if inflowing capital will only match with skilled labour, while unskilled labour is not or even negatively affected?"...the possibility must be considered that international labour market,...,operated in such a way as to match machinery and equipment with skill, not only with the least expensive labour that could be found." [Hanson II (1995 p. 156)]. Even if there are some contributions to the discussion of employment effects of capital mobility and FDIs [see e.g. Koizumi/Kopecky (1980), Lall (1995), or more recently Glass/Saggi (1999)]5 there is still little known about the structure effects on different labour market segments. It is not clear, if the important problem of increasing labour market inequality and large unemployment in the unskilled segment of the labour market will be positively affected by FDIs. The goal of this contribution is to obtain a better understanding of the unemployment effects of capital mobility on different segments of the labour market. While the Harris-Todaro model is the workhorse in development literature for analysing persistent unemployment problems, we suggest the labour market matching-approach as an interesting alternative for analysing the defined problem.6 In a labour market flow model the continuous separation of existing jobs and a growing population indicate the inflow of unemployed 4

See e.g. Wood (1994, 1995, 1997, 1998), and also chapter seven in this volume. For a general discussion see also Gilroy (1999). 6 A major problem concerning the analysis of unemployment in developing countries is a limited number of theoretical approaches. Fields (2000 p.5) mentioned: "There does not yet seem to be a labour market model that properly incorporates the main stylised facts." Therefore, we suggest the labour market flow approach as an additional tool for discussing the problem of persistent structural unemployment. 5

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

231

persons into the labour market. On the other hand firms offer vacancies of newly created jobs as well as existing but presently vacant jobs. The number of vacancies offered to the market depends on the cost of employment as well as the costs of job creation or reemployment. The matching of the job profile and the workers skill and ability profile determines the outflow of unemployed workers out of the labour market. The sum of the separation rate, the population growth rate, and the job-matching rate gives the net change in unemployment. If the inflow and outflow rates are equal, labour market is in a stationary equilibrium, i.e. the labour market faces a flow equilibrium with persistent unemployment. In the model used to analyse the impact of FDIs on employment two segments of the labour market are distinguished, one for skilled and one for unskilled workers. For each segment the long term unemployment equilibrium is derived. Allowing for international capital mobility we analyse the effect of FDIs on relative factor prices, optimal factor allocation and the opportunity costs of vacancies in the different segments of the labour market. The main finding is that skilled labour will always gain from increasing FDIs while the effect on the unskilled is ambiguous. The ambiguous effect for unskilled is the result of a general positive effect of FDIs on aggregate employment and a negative reallocation affecting the unskilled. The negative effect can be reduced or even reversed if FDIs are complemented by policies like imports of foreign experts or additional human capital investments.

9.2 THE MODEL 9.2.1 Workers We consider an economy with a large number of households and identical firms. The aggregate labour endowment of households, L, is constant and there are two types of workers, skilled and unskilled. The unskilled workers, Lu, offer raw labour services while the skilled workers, Ls, offer human capital services. The aggregate distribution of both types of workers is constant. At any point in time workers of each type are either employed or unemployed and searching for a job. The number of employed and unemployed workers is denoted Nj and Uj respectively, with Uj=Lj,

j = u,s

(9.1)

9.2.2 Firms Firms demand capital and labour services to produce a homogenous good. The number of goods produced by a single, representative firm i is denoted X1.

232

T. GRIES and S. JUNGBLUT

The production function is a nested CES-function with raw labour services, £, and capital services, /C, as upper level inputs:

with flic = (1 — /?£). We suppose that the substitution parameter 7 is positive. Thus, the elasticity of substitution d = j ^ — is less than one and raw labour services and capital services are considered to be complementary inputs.7 Raw labour services are measured in efficiency units, L = \NU, where A, denotes a productivity parameter with constant growth rate A. Capital services K include human as well as real capital service and are produced according to a Leontieff technology with factor productivity

1C =

KK = K

(9.3)

With this assumption we introduce the hypotheses of complementary skills and modern real capital. The human capital input Hl is measured as the number of skilled workers times per capita human capital endowment h: H* = hNls Since the production function (9.2) is homogenous of degree one, aggregate output is given by

X = F(Nu,Ns,h,\): = [t hNs =

K-1K.

(9.4)

Given that 7 > 0 the basic assumption about the production technology is that technical progress is (unskilled) labour augmenting which in turn requires real as well as human capital services to become effective. 9.2.3 Factor Income and Accumulation Let Wj denote the wage rate per worker of type j ; r the net user cost of capital, and n redistributed profits. Then, labour income, YL , and capital income YK are given by YL = w N + w N

YK=J+rK 7

For empirical support and further discussion of this assumption see OECD (1996), p. 100.

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

233

Factor accumulation equals income less consumption. We suppose that the accumulation of real capital, K = dK/dt is a constant fraction s of real capital income K = sYK,

(9.5)

and human capital accumulation, H = dH/dt , is financed by public expenditure. The educational spending is assumed to be a constant fraction r of mass or labour income: = hLs =

TYL

(9.6)

9.2.4 Labour Markets The adjustment dynamics of employment are determined by the search activities of workers and the job creation and reemployment activities of firms. The search activity of workers is measured by the number of unemployed in each segment of the labour market8, Uu and Us , while job creation and reemployment activities of firms is measured by the number of vacancies offered for each type of worker, Vu and Vs. Moreover, the number of successful job matches at any point in time, Mj, is considered to be a function of search activities and vacancies. Mj = Mj(Uj,Vj),

j = u,s

(9.7)

We assume that the matching function Mj(.) is linear homogenous. Thus, the probability to close a vacancy as well as the probability to find a job is a function of the ratio of Vj to Uj only. These probabilities are denoted M•^• = Mj(Uj/VJ,l)=:q{ej),

(9.8)

^

(9.9)

:p{0j)

where 6j = Vj/Uj denotes the tightness of labour market segment j = u,s. The partial derivatives satisfy dq(6j)/d0j < 0 and dp(6j)/d6j > 0. The matching function (9.7) describes the outflow of labour market j — u, s. The inflow of labour market j is given by the number of jobs which are separated at any point in time. For simplicity the separation rate Sj is assumed to be constant. Thus, the change of employment, JV,-, is 8

For simplicity, on-the-job search activities are not considered.

234

T. GRIES and S. JUNGBLUT Nj = Mj - <jjNj = Vjq(Oj) -

ajNj

The labour market is in a flow equilibrium, if inflow equals outflow: Nj = 0 & VjqiOj) = ajNj

(9.10)

9.2.5 Vacancies A vacancy is a newly created job or the reemployment of a presently vacant job offered to the market. The number of vacancies offered by firm i, Vj, is the control variable to adjust employment. Since firms are small and cannot individually influence the aggregate number of vacancies, 0j is taken as given at the firms' level. The creation of a new job as well as the adjustment for reemployment of an existing job absorbs resources. Let cVj denote the real value of resources necessary to offer an additional vacancy of type i. Then, reemployment expenditure of firm i in market j equals cVj Vj. The present value of profits then is

i, A,/C) - wuNt - wsNi - cVuV> - c . t ? - rK'jdt, where p denotes the firms discount rate. Since profit maximisation implies K = nhNs the maximisation problem is m&xNjVj 7rj := /0°° ePt{F(Ni, Nl, A, h) - wuNt - (ws + rnh)Ni - c ^ - ^.V* -

rK^dt,

subject to

for j = u, s. This problem can be solved by setting up the present value Hamiltonian function H(N^,Nl,V^,V^, fj,u, fis,t) with fij as the costate variables. In addition, let FJV, denote the partial derivative of F(.) with respect to Nj. Then, the Hamiltonian conditions are Q

=W]^

° = -eptc^

+ W(6i)> t

J = M>s'

\-FN-u ~ wu\ - Vu
i -wa-cTjNi,

rnh\ - (iaaa, j = u,s.

(9.11a) (9.11b) (9.11c) (

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

235

and the transversality condition is 9 lim Hit) = 0 a:—>oo

If (9.11a) is differentiated with respect to time and the result is substituted for fij in (9.11b) and (9.11c), respectively, we arrive at FNu -wu-

cVuq{6u)-1 K + p - cVu/cVu - vju/0u\

FNus ~ K + ™h) - C^q^s)-1

= 0,

[CTS+P- CvJcVe - VS9S/6S\ = 0.

(9.12a) (9.12b)

In this form of the first order conditions Vj is used to denote the elasticity of q{Oj)~l with respect to 0j . Together, both conditions determine the number of vacancies supplied as a function of the workers marginal productivity, the wage rate (adjusted for capital costs) and the expenditures necessary to maintain or further adjust employment. Since F^. is identical for all firms and the production technology is linear homogenous in physical labour inputs, the conditions can be used to describe individual as well as aggregate search activities. 9.2.6 Job Creation and Reemployment Costs The cost to offer a vacancy is measured in units of the final good. In particular we assume that - at least in the long-run equilibrium—the cost is constant relative to output cVj=CjX.

j = u,s

(9.13)

Since the driving forces of output growth are human capital accumulation and technological progress equation (13) implies that the cost to supply a vacancy is positively related to these factors 10 . We further assume that the cost to supply a vacancy is higher for skilled workers than for unskilled workers, i.e. cs ^> cu.

The equations described so far are not sufficient to determine the behaviour of wages endogenously. One hypothesis to determine factor payments extensively discussed in the context of search models is to describe wages as the outcome of a bargaining process between firms and workers 11 Although we think that this approach is reasonable, it would nevertheless substantially complicate 9

See Michel (1982) for a discussion of this type of transversality condition in infinite horizon control problems. 10 If Cj were not constant in a growing economy, the costs of vacancies would be asymptotically zero or infinte relative to production which we think would be a counterfactual assumption. n See e.g. Mortensen (1978), Diamond/Maskin (1979), Diamond (1982), Pissarides (1985, 1990).

236

T. GRIES and S. JUNGBLUT

the structure of the model. To approximate this wage hypothesis and keep the wage determination simple we assume that the wage rate is proportional to the marginal productivity of labour Wj = uFN.

0 < w < 1,

(9.14)

where w may be understood as the result of a bargaining process not modelled explicitly.

9.3 STEADY-STATE SOLUTION 9.3.1 Equilibrium Conditions The economy is in steady-state if both labour markets are in a flow equilibrium (Nj = Vj = 0) and the growth rate of real and human capital endowment equal the growth rate of technological progress (K = h = A). To analyse the economic implications of these long-run equilibrium conditions we first use equations (9.1), (9.9) and condition (9.10) to express equilibrium employment as a function of labour market tightness 6j = Vj/Uf j = u,s

(9.15)

It is straightforward to show that dNj/dOj > 0, d2Ni/d62j < 0, and dUj/dOj < 0, d2Uj/d9"j > 0. Thus, the steady state level of employment for workers of type j is positively related to the equilibrium level of search activity and labour market tightness 0j, respectively. Therefore, the labour market effects of the parameters of the model can be analysed by looking at their impact on Qj, keeping in mind that the higher 6j the higher the equilibrium level of employment of workers of type j . To derive the equilibrium values for 6U and 9S we first make use of the accumulation conditions (5a) and (6). In any stationary equilibrium these conditions imply

Taking the definition of YL and YK into account, this condition can be equivalently expressed as

with

Thus, the function 4>(6U,9S,...) describes an inverse relationship between 6U and #,:

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT _ ~

d<s>/aeu d/aes ^

237

n u

Which of the possible search combinations of (9.16) will finally result depends on the first order conditions (9.12a) and (9.12b). Since in any stationary equilibrium 0j = 0, cVj = X = A, and n-A=f-

x

-

.

aa+p{fls),

these conditions can be expressed as 12

(9.17) and c,es

0=1-T±- rK-

(9.18)

8,

Fig. 9.1. Equilibrium Search Activities. It is straightforward to show that for any given r

Equations (9.16), (9.17) and (9.18) simultaneously determine the long-run equilibrium values for 6a, 6U and r (see Figure 8.1). 12

1-

To derive conditions (9.17) and (9.18) we made further use of the fact that "

N^ _

FNaNa

_

„ r x

ip

238

T. GRIES and S. JUNGBLUT

9.3.2 Economics of the Steady State The level of search activities as represented by equation (9.16) is mainly a function of u> . This variable indicates the share of labour income. Obviously, &(&u, @s, • • •) will shift outwards in the 6U — 6S plane if u> decreases. This reaction is straightforward because a lower labour share increases the incentives to search for additional workers. However, equation (9.16) also implies that for any given level of aggregate search activity there also exist an inverse relationship between search activities for different types of workers and thus an inverse relationship between the employment levels of skilled and unskilled. This inverse relationship results from the long run-resource constraint of the economy - the accumulation of different types of capital. Equation (9.16) shows that for any given employment level of unskilled workers, NU(9U) , the employment level of skilled workers, N(9S) , will be the higher the higher (S/T)/K. Thus, the higher the accumulation ratio (S/T relative to the input ratio K the higher the search activity and employment level for skilled workers. The first order conditions (9.17) and (9.18) finally determine which of the feasible search combinations implied by (9.16) will result in equilibrium. A closer inspection of these conditions shows that the equilibrium levels are basically functions of the relative productivity of each type of worker. In particular, it is immediately obvious from equation (9.18) that the level of employment of skilled workers is positively related to the rate of technological progress A . Thus, the unskilled-labor augmenting property of technological advances immediately translates into higher search activities for the skilled, and - due to the long-run resource constraint (9.16) - a higher level of unemployment among the unskilled.

9.4 EMPLOYMENT EFFECTS OF FDIs 9.4.1 Pure Effects of Inflowing FDIs Given the importance of the long-run resource (accumulation) constraint of the economy it is straightforward to ask about the labour market impact of foreign direct investments (FDIs). We assume that FDIs are driven by interest arbitrage. That is, in this approach we focus on a macro-oriented comparative cost view at the supply side of the firms (Ruffin (1984)). Even if most summarising literature (see e.g. Caves (1982) or Borner (1983,1985) or Gilroy (1993)) discuss the various arguments against a strict application of the capital arbitrage approach, there is evidence that from the long-run macro perspective capital arbitrage still seems an important determinant of international direct investment (Haynes (1988)). Therefore, for the analyses in this model international interest arbitrage seems a suitable approach. To analyse this question we will assume that in the initial situation the country

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT 239 is relatively scarce in physical capital, resulting in a relatively high real rate of interest r as compared to the world market price f. If the country opens for FDIs an immediate consequence of the additional access to physical capital will be that the resource constraint represented by the accumulation function (9.5) does no longer bind. Consequently, equation (9.16) does not restrict search activities in labour markets. Instead, the first order conditions (9-17) and (9.18) now simultaneously determine the tightness of labour markets 9U and 6S for the world market interest rate f. M^,e,,f,...) = o,

(9.19)

&(0 u ,0 s ,f,...) = O,

(9.20)

To understand the impact of a reduction of r on the search activities for both types of labour we combine equations (f)u{.) = 0 and s(.) = 0 to derive the open economy equivalent of the aggregate resource constraint (9.16): n

_ -, _

_ cueu[au

=

cf>(eu,es,f,...),

The derivatives of this equation satisfy 19

^

<°

and for any given 9U de

>

0

Thus, similar to the closed economy we obtain a resource constraint which implies an inverse relationship between search activities in different segments of the labour market. Moreover, the negative derivative of 6S with respect to f implies that aggregate search activity is inversely related to f. The outward shift of the resource constraint ip(.) = 0 (Figure 9.2) induced by a decrease in f indicates that the economy will be able to reach a higher level of economic activity after opening for FDIs. The impact on economic activity then translates into a higher aggregate search activity for labour services. This effect is due to the fact that the real interest rate is part of the opportunity cost of firms when investing into search expenditures instead of real capital. The additional supply of physical capital from FDIs will reduce these opportunity costs and thus - other things being equal - makes it more attractive to employ additional workers. In addition to their impact on aggregate search activities FDIs will, however, also have a disaggregated effect. The additional supply of physical capital increases the demand for human capital and thus the incentives for firms to search for the skilled. This effect is captured by equation (9.18) and the derivative

240

T. GRIES and S. JUNGBLUT ' dB/d9e

dfi.

<0

In Figure 9.2 the s - curve shifts upward. Obviously, the effects of FDIs on employment of the skilled are unambiguously positive. Both, the higher level of aggregate economic activity as well as the higher demand for human capital services will help to improve the labour market conditions for the skilled.

e. F

\ \

\B

\ \

'

\A V ^^\ :\

i »• • •

• ,(6, r

/

case b

/

case a

}

Is.

h>Fo> — ) —___

Fig. 9.2. FDIs and Employment The effect of unskilled workers, however, remain unclear. On the one hand [case (a), point A], the higher level of aggregate economic activity will increase the demand for unskilled labour services as well. On he other hand, the inverse relationship between search activities in both segments of the labour market means that the increased demand for human capital services reduces the incentives to search for and employ the unskilled. If this effect is dominant, unemployment for unskilled may increase [case (b), Point B 2]. The overall impact of FDIs on the employment of unskilled workers thus depends on which of both partial effects will dominate. If high unemployment of unskilled worker is a major political problem, it is important to know more about the conditions and policies to generate unambiguous positive employment effects. 9.4.2 FDIs and Increasing the Number of Skilled The ambiguous impact of FDIs on the employment level of unskilled workers is an immediate result of the complementary of human and physical capital services. As a result the positive partial impact of FDIs on the employment of unskilled workers will be reduced or even reversed unless the supply of human capital services increases accordingly. However, when discussing these issues it is important to distinguish between the supply of skills and the supply of

9 EMPLOYMENT EFFECTS OF FOREIGN DIRECT INVESTMENT

241

skilled workers. In particular, according to the model increasing the number of workers having access to the educational system, Ls without an increase in the rate of educational expenditures will strengthen the adverse effect for the unskilled. To see this, first note that according to condition (9.18) dL3l,

<0

Fig. 9.3. Effects of Increasing Ls Thus, the upward shift of 4>s in the 0u-6s plane induced by the higher demand for skilled labour services could in fact partially be reversed by increasing Ls. However, since equation (9.17) remains unaffected it becomes immediately clear that effect for the demand of unskilled workers is negative, too (see Figure 9.3). This surprising result points out to the fact that it is insufficient to increase the number of skilled workers. What is needed instead is increasing the rate of expenditure for education, r. Since firms must search for workers to get access to human capital a larger but less educated number of skilled effectively increases search expenditures for skilled which is partly paid for by a reduction in search activities for the unskilled. 9.4.3 FDIs and Inflowing Foreign Experts To effectively increase the supply of human capital it is therefore necessary to either increase educational expenditure or - which is cheaper - to open the country for real and human capital imports. To see that both policy measures will have an almost identical effect on employment consider equation (9.6). If z = Hd/H denotes the ratio of domestic to total human capital after the country's opening the steady state accumulation path for the economy can be expressed as

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- ITT Thus, as expected importing human capital (reducing z) increases the gross rate of accumulation T/Z. The labour market effects of this policy will become immediately obvious once we consider the first order conditions

Fig. 9.4. Effects of Human Capital Imports

=

u{0u,0s,f,Z,...),

and 13

It is straightforward to show that for any given 9U dz\.

d0, dz \<>-u(5u,r,z,...)

Thus, the net effect for unskilled workers is unambiguously positive as shown in Figure (9.4). Moreover, the positive effect of human capital imports is even stronger than the effect of a simple increase in r , because the additional supply of workers Ls/z further slackens the labour market for skilled and improves employment conditions for the unskilled. 13

To simplify the exposition, but without loss of generality we assume that the human capital endowment of skilled domestic and foreign workers is the same. Thus Lds/Ls = z

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9.5 SUMMARY AND CONCLUSION Opening for capital mobility and attracting FDIs generally has positive level effects on the firms job offers and hence on employment. But, the structure and reallocation effects are not unambiguously clear for all types of labour. While skilled labour will benefit from an increasing effort of firms towards additional employment, the effects on unskilled labour are not undoubtedly positive. Given that the original effects of inflowing FDIs are negative for the employment of unskilled, additional policies can compensate for this negative result. A policy to reverse the potential negative impact might be a simultaneous inflow of foreign experts or an increase in the quality of domestic human capital by increasing investments in education. Therefore, allowing for the inflow of FDIs may accelerate growth and development. In order to take care of the employment problem - especially with respect to unskilled labour - economic policy should also allow for the inflow of foreign experts accompanying FDIs. Additional investments in human capital or the inflow of foreign human capital will foster employment of unskilled.

REFERENCES Bell, T., Cattaneo, N. (1997). Foreign Trade and Employment in South African Manufacturing Industry. Occasional Report no. 4, Training Department, International Labour Office, Geneva. Cline, W. (1997). Trade and Income Distribution. Washington DC: Institute for Inter-national Economics. Diamond, P. A., Maskin, E. (1979). An Equilibrium Analysis of Search and Breach of Contract, I: Steady States, Bell Journal of Economics, 10, Spring: 194-316. Diamond, P. A. (1982). Wage Determination and Efficiency in Search Equilibrium, Review of Economic Studies, 49: 217-27 Edwards, L. (1999). Trade liberalisation, structural change and occupational employment in South Africa. Paper presented at the Trade and Industrial Policy Secretariat Annual Forum, Muldersdrift, 19-22 September. Edwards, L. (2000). Labour shedding output growth: Is trade the culprit? Trade & Industry Monitor, vol. 14: 2-6. Fields, G. (2000). The Employment Problem in South Africa. Trade & Industry Monitor, vol. 16:3-6.

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GEAR (1996). Growth, Employment and Redistribution. A Macro-Economic Strategy. Department of Finance, Pretoria. Gilroy, Bernard Michael (1993). Networking in Multinational Enterprises: The Importance of Strategic Alliances, South Carolina University Press, Columbia. Gilroy, B. M. (1999). Beschaftigungswirkungen multinationaler Unternehmungen. Jahrbuch - Okonomie und Gesellschaft, 15, Frankfurt, New York: Campus Verlag:306-332. Glass, A. J., Saggi, Kamal (1999). FDI policies under shared factor markets. Journal of International Economics, vol. 49: 309-332. Gottschalk, P., Smeeding, T. (1997). Cross national comparisons of earnings and income inequality. Journal of Economic Literature, vol. 35, no. 2: 633-87. Hanson II, J. R. (1995). Is Cheap Labor a Magnet for Capital? Journal of Economic Education: 150-156. Hofmeyr, J. (2000). Inequality, Unemployment and Wage-setting Institutions in South Africa. Studies in Economics and Econometrics, vol. 24, no. 3: 109128. Koizumi, T., Kopecky, K. J. (1980). Foreign Direct Investment, Technology Transfer and Domestic Employment Effects, Journal of International Economics, 10: 1-20. Lall, S. (1995). Employment and foreign investment: Policy options for developing countries. International Labour Review: 521-540. Leibbrandt, M, Nattrass, N. (2000). Introduction to Special Edition. Studies in 18 Economics and Econometrics, vol. 24, no. 3: 1-6. Michel, P. (1982), On the Transversality Condition in Infinite Horizon Optimal Problems, Econometrica, 50, 4: 975-85. Mortensen, D. T. (1978), Specific Capital and Labour Turnover. Bell Journal of Economics, 9, Autumn:572-86. Murphy, K., Topel, R. (1997). Unemployment and nonemployment. American Economic Review, vol. 87, no.2:295-300. Nattrass, N. (1998). Globalisation and the South African Labour Market, Trade and Industry Monitor, 6: 18-20.

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OECD (1996), The OECD Job Strategy, Vol. II: Analytical Report, Paris: OECD. OECD (1997). Trade, earnings and employment: assessing the impact of trade with emerging economies on OECD labour markets. Employment Outlook, OECD. Pissarides, C. (1985), Short Run Equilibrium Dynamics of Unemployment, Vacancies and Real Wages, American Economic Review, 75, 4:676-690. Pissarides, C. (1990), Equilibrium Unemployment Theory, Oxford: Basil Blackwell. Whiteford, A, van Seventer, DE (2000). Understanding Contemporary Household Inequality in South Africa, Studies in Economics and Econometrics, vol. 24, no. 3: 7-30. Wood, A. (1994). North-South Trade, Employment and Inequality: Changing Fortunes in a Skill-Driven World. Oxford: Clarendon Press. Wood, A. (1995). How trade hurt unskilled workers. Journal of Economic Perspectives, vol. 9, no. 3: 57-80. Wood, A. (1997). Openness and wage inequality in developing countries: the Latin American challenge to East Asian conventional wisdom. World Bank Economic Review, vol. 11, no.l: 33-57. Wood, A. (1998). Globalisation and the Rise in Labour Market Inequalities, Economic Journal, 108: 1463-1482.

10 HUMAN RESOURCE DEVELOPMENT: A SINE QUA NON FOR FOREIGN DIRECT INVESTMENT IN SOUTH AFRICA W. NAUDE1 and W. KRUGELL2 1 2

North-West University, South Africa North-West University, South Africa

10.1 INTRODUCTION3 Foreign Direct Investment (FDI) refers to net inflows of investment from abroad to acquire a lasting management interest (10 per cent or more of voting stock) in an enterprise operating in an economy other than that of the investor. FDI has three components: equity investment, reinvested earnings and short-and long-term inter-company loans between parents and foreign affiliates. In 2001 the total volume of FDI flows across the globe amounted to US $ 1.3 trillion. FDI supplies capital and provides for spillovers of foreign technology and know-how to host economies. This may aid growth and development. As had been shown in chapters 1 and 2, FDI remains vitally important for Sub-Saharan Africa to obtain sufficiently high economic growth so as to reduce unemployment and poverty. The South African challenge in particular is clear from the following. Between 1994 and 2000 the average annual, economic growth was only 2.7% and substantially below the target of 6% identified in the Growth, Employment and Redistribution (GEAR) macro-economic strategy as necessary to start making inroads into unemployment. Despite sharp depreciation in the Rand exchange rate in 1996, 1998 and 2001 strong and sustained export growth did not yet take place. Employment in the private sector declined by 15% between 1994 and 2000 and the unemployment rate (broadly denned) is estimated at 37%. One of the major reasons for South Africa's slow growth is the poor investment response by the private sector. Indeed South Africa is investment constrained 3

An earlier version of this chapter was presented at the 3 r d Regional

International Industrial Relations Association Congress for Africa, Hosted by the I n d u s t r i a l R e l a t i o n s A s s o c i a t i o n of S o u t h Africa, C a p e T o w n , 5 - 8 M a r c h 2002.

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with investment by private business that stagnated since 1994 and is now (at 10.7% of GDP) lower than in 1994. Especially disappointing was the poor inflow of FDI after 1994 and in comparison to other developing countries South Africa received very little FDI inflows since 1998. In this South Africa shares the broad African experience: despite the fact that returns on FDI in Africa was almost 60% higher than that in other developing regions during the period 1990-944, it attracted less than 2% of allflowsto developing countries by 1995 (roughly US $2bn. Per annum, exc. South Africa) (see Jaspersen, et al., 1998; Bhattacharya, et al., 1996). We argue in this chapter, in the light of Gries and Jungblutt's model in chapter 9, that one of the major reasons for the slow inflow of FDI into South Africa since 1994 is due to the country's inadequate supply of human capital. It is important to note at the outset that physical and human capital work in a complementary fashion - if human capital cannot - due to inappropriate human resource development - complement physical capital, investment will be reduced. Gries (1995a,b) analyses the role of human capital accumulation in the international allocation of goods and capital and finds that if human and real capital are complements, the domestic availability of human capital may determine the rate of domestic physical investments. The degree to which human capital can act as a complement to physical capital depends in part on the skills of the labour force (Gries, 1995a). A skill relates to the ability to use a certain technology. Technologies are embodied in capital goods: A certain capital good embodies a certain technology by the productive properties of the machinery. Hence the technology defines the link between human capital and real capital. This fixed link implies that a country with a certain human capital stock and structure will efficiently employ the adequate stock and structure of real capital. As such human resource development strategies could play an important role to complement the investment promotion activities of the South African government and its investment promotion agencies (IPAs) by providing human resources with the appropriate skills. The chapter is structured as follows. In section two the FDI profile for South Africa is given. Section three discusses the determinants of FDI. Section four introduces human resource development as a crucial determinant for FDI. Section five concludes with an assessment of South Africa's human resource constraints (from an FDI view) and makes some recommendations for a human resource development strategy that will assist the government and its IPAs in attracting FDI to South Africa. 4

Since 1990, the rate of return in Africa has averaged 29 per cent; since 1991, it has been higher that in any other region, including developed countries as a group.

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10.2 THE PROFILE OF FDI IN SOUTH AFRICA In 1996 the South African government adopted the GEAR macroeconomic strategy. It replaced the inward-looking and interventionists policies of the Apartheid government. The GEAR macroeconomic strategy seeks to make the private sector the engine of growth and to fully integrate the South African economy into the global economy. In particular, the South African government has substantially liberalized international trade with the aim of expanding job creation through export-led growth and higher FDI. As stated by the DTI (TISA; see website www.tisa.org.za), key tenets of the GEAR-strategy that are aimed at presenting an attractive and viable investment destination to foreign investors include fiscal deficit reduction, trade and foreign exchange rate liberalization, the restructuring of state assets, and the promotion of skills and development. These are all recognized to be necessary conditions for increased flows of FDI. In addition, South Africa has made courageous efforts to open up the domestic economy to international competition through: •

The lowering of tariff barriers, ahead of the WTO timetable agreed to in 1994; • A market related and competitive exchange rate; and • The conclusion of FTAs with SADC and the EU and the expansion of these in the near future to Mercosur countries. In an opened-up, global market place, South African firms need to improve their competitiveness if they are to survive and prosper. A proper understanding of the very concept of competitiveness (see below) suggests that improving the competitiveness of South Africa as a location for firms should be an important pillar of South Africa's economic development strategy. According to the overall ranking of the WEF in its annual ACR, South Africa is ranked the 7th most competitive country in Africa5. The performance of the South African economy since the adoption of GEAR has been disappointing. Economic growth rates during 1998-2000 were below the projected 4% in GEAR - and more around 2.7% as noted in the introduction. According to TIPS (2000:5) the basic reasons for this disappointing growth is due to poor investment rates, "especially foreign direct investment which has failed to materialize in the quantities expected". Between 1998 and 2000 the volume of FDI into South Africa was in the region of US$ 3 billion (less than 1% of total world-wide FDIflows).Not only has South Africa's absolute levels of FDI inflow been low, compared to other developing countries the inflows are also low. Between 1994 and 1999 South Africa attracted $32 5

The six most competitive countries in Africa are (in order): Tunisia, Mauritius, Botswana, Namibia, Morocco and Egypt.

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per head of FDI inflows, compared with $106 for Brazil, $252 for Argentina and $333 for Chile. Furthermore, between 1994 and 1999 more capital left South Africa than flowed into the economy: FDI outflows amounted to $9.8 billion over this period compared to the total inflow of FDI of about $8 billion. Furthermore, FDI inflows typically contribute roughly 10 per cent of gross fixed capital formation in developing countries world-wide (UNCTAD, 1999). However in South Africa, the ratio of net FDI flows to gross capital formation reached a peak of 6.2% in 1997 and has subsequently declined. Net FDI inflows amounted to 6 per cent of gross capital formation in South Africa in 1997, and -5.3 per cent of GCF in 1998, recovering to 1.6 per cent of GCF in 2000. The high levels of FDI in 1997 were achieved with the partial privatisation of state assets: Telkom and the Airports Company among them. Figure 10. 1 below gives a profile of net FDI flows to and from South Africa up until 2000. What is particularly noticeable is that net FDI is particularly volatile, with significant positive and negative spikes.

-15000

I F D I nIf l o w s

O F D l Outflows -Net

FDI

Fig. 10.1. Trends in Net Foreign Direct Investment into South Africa

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Figure 10. 2 below contains a comparative view on FDI in South Africa. Its shows that South Africa is almost at the bottom of the ladder in terms of the inflows of FDI amongst developing countries.

Czech Republic Brazil Poland

"Ina Philippines Zimbabwe

E

L_s m6

Fig. 10.2. Comparative Shares of Average Net Foreign Direct Investment Inflows

Both Prior to and After the Asian Arisis. Net Foreign Investment Flows are Shown as a Percentage of Gross Capital Formation The dominance of East Asian countries in the above graph is noticeable and is something that we will comment on below. The most important countries of origin (or rather where the firms come from) of FDI inflows into South Africa tend to be (with some minor variation in or-

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der of size) the USA, UK and Germany. In recent years Malaysia, Switzerland and Ireland have also been significant investor-countries (see Heese, 1999). Most post-1994 FDI in South Africa went into the services sector and-related industries such as information and communication technology (IT). For instance TNCs have found sectors such as transport and transport equipment, telecommunications and information infrastructure to be preferable sectors for investment. According to Cassim (2000:14) this may be because investment in manufacturing in South Africa may not be as attractive to the type of TNCs as investment in services as that investment in IT and communication in South Africa is driven by the government's deregulation and privatization of the sector6. The largest proportion of FDI in South Africa is in the form of mergers and acquisitions, as shown in table 10.1 below. Thus 60% of South Africa's FDI consist solely of the transfer of existing assets from domestic to foreign firms.

(~ergers and acquisitions

Investment

Liquidation Disinvestment

160.4% 17.3% 16.7% 4.5% 3.1% -0.6% -1.5%

Table 10.1. Forms of FDI in South Africa (19941999)

It is often pointed out that there are different types and modes of foreign direct investment. Thus mergers and acquisitions are seen as being less favourable for economic development of a host country than mergers and acquisitions because the latter merely entails a change in ownership and is usually followed by job reductions and restructuring. In contrast, so-called "Greenfield- FDI" brings in new capital and is seen to be better for job creation and growth. Another distinction that is sometimes emphasized is between FDI that intends to supply the domestic market, and FDI that intends to supply foreign markets. The former is often seen as competition for domestic businesses, whilst the 'since 199617 the South African government commenced with a privatisation programme that included the partial sale of shares in large parastatals (often in monopolistic positions) such as Eskom (providing electricity), South African Airways, Transnet (in road and rail transport) and Telkom (providing the only land-line telephone service in South Africa). In addition the cellular (mobile) telephone market was deregulated in 1999/2000 with the granting by government of a 3rd licence for a service provider.

10 HUMAN RESOURCE DEVELOPMENT

Forms of FDI in SA Average annual % (1994 - 1999)

Mergers 8 Acquisitions W Expansions ONew

Investment WIntenSons

Fig. 10.3. Forms of FDI in South Africa (1994-1999)

latter is not - and generates foreign exchange for a country through its exports. However, it must be noted that domestically oriented foreign investors often have closer links with local firms and can provide useful know-how and other basic technology to local firms. Through this they can enhance the export potential of indigenous entrepreneurs. 'LGreenfield"type of FDI is thus preferable from a human resource development perspective.

10.3 DETERMINANTS OF FDI South Africa's (and many other African countries') experience since 1994 shows that free tradeloutward-orientation alone is not sufficient to ensure FDI inflows. This raises the frequently asked question about the determinants of FDI. Wang and Swain (1997) classify host country characteristics into micro-, macro- and strategic determinants of FDI. We will here deal with micro and macro-determinants and we will argue that the lack of adequate incorporation of human resource development as determinant is a significant omission that might explain the lack of predictive power of models build on these determinants as well as the frustrating failure in many countries to attract sufficient FDI using policies and programmes based on these determinants. 10.3.1 Micro-determinants of FDI

The micro-determinants of FDI are mainly concerned with those locationspecific factors that have an impact on the profitability of FDI at firm or industry level. Host country characteristics that influence productivity and

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cost at this micro-level include market size and growth, labour costs, host government policies and tariffs and trade barriers. •

Market Size and Growth FDI is likely to be attracted to host countries with large local markets and higher levels of economic development. A large, growing domestic economy ensures the TNC of a market for its product and provides for scale economies (Lucas, 1993). Transaction costs are also likely to be lower (McMillan, 1995). Evidence from empirical studies provides strong support for the importance of market size as a determinant of FDI. Wang and Swain (1997) surveys a number of early studies from the 1960s and 1970s and concludes that most studies come out in support of the size or growth of the markets in the host countries, as a significant determinant of FDI. In more recent work, Schneider and Frey (1985) and Wheeler and Mody (1992) finds market size to be related to FDI flows.

•

Labour Costs Labour costs are a clear consideration in a TNC's decision to employ its ownership advantages outside its home country. As wages rise, FDI aimed at low cost, efficient production, tends to be discouraged. Though, as wages rise relative to the cost of capital, there may be a tendency to substitute foreign capital in the place of labour (Lucas, 1993). Firms may also not only be interested in the lowest wages. TNCs may seek skilled labourers and professionals (Veugelers, 1991). Rather than just low wages, it is important that wages reflect productivity (Wang & Swain, 1997). TNCs aim to maximise profits through efficiency gains and/or cost minimisation. A related factor to take into account is that of labour disputes. A given host country is less attractive the greater is the incidence or severity of industrial disputes (Yang et al., 2000). The results of time series and cross-country analyses are also strongly in favour of relative low wages as a significant determinant of FDI flows. Specifically in the case of developing countries, Wheeler and Mody (1992) and Lucas (1993) find a positive and significant relationship between lower labour costs and FDI inflows. Urata and Kawai (2000) ties this in with the nature of the TNC. They find that relative low wages are an important determinant of FDI by Japanese small and medium-sized enterprises (SMEs). The Japanese SMEs produce in neighbouring Asian countries in order to reduce their factor costs. Production is then exported back to Japan.

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In contrast, larger firms are more concerned with local sales and the size and growth of the host market. •

Host Government Policies Host government policies are location specific factors that may influence profitability and TNCs' decision to undertake FDI, in a number of ways. Such policies include incentives and performance requirements (UN, 1995). Host governments often offer incentives to increase the attractiveness of their location. The incentives aim to encourage FDI inflows by reducing costs and making investment more profitable. Specific measures include tax breaks and trade incentives, like duty-free imports of inputs. The incentive schemes are often closely linked to efforts by the host government to encourage investment in export industries, or preferred sectors, or in less developed areas of the country. Most host countries believe that incentive schemes are crucial for attracting FDI, because competing economies have similar schemes. Related to incentives are performance requirements. A host government can place performance requirements on investors to try to ensure that the benefits of FDI accrue to the country. This takes the form of requirements concerning the hiring and training of local personnel, local content, technology transfer and exporting of output. Where incentive schemes may attract FDI, the interference of government performance requirements may deter it. To negate this possible negative effect governments often link meeting the requirements to fiscal incentives like tax rebates. The empirical literature, however, finds the impact of government policies to be less straightforward. Helleiner (1989) finds that specific incentives do not have a major impact on FDIflows.Incentives influence the decisions of investors only at the margin. Dees (1998) adds to this, citing a survey according to which investment incentives are only moderately significant for the decision of US firms to invest in China. The evidence does show that removing restrictions and providing good business operating conditions will affect FDI flows positively.

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Tariff and Trade Barriers The so-called "tariff hopping" hypothesis states that high protective trade barriers make exports by TNCs to a potential host country, uncompetitive. Potential marketing cost savings, from avoiding protectionist barriers, as well as transport cost reductions, encourage TNCs to rather enter the market through FDI and to serve their customers with local facilities (Wang & Swain, 1997). A growing internal market will add to the attractiveness of tariff hopping. Jun and Singh (1996) tests the tariff hopping hypothesis and finds the relationship between taxes on international trade and transactions, and FDI, to be positive and significant. Yung et al. (2000) supports this result but with a different method. Measuring the openness of the Australian economy as the sum of exports and imports as percentage of GDP, they find a negative relationship with FDI. They subsequently argue that FDI inflows substitute for trade, much like the case made in the tariff-hopping hypothesis. It should be noted that the influence of these location-specific microdeterminants of FDI depends on a number of factors. Firstly, the nature of the investment is important. If the investment is for export production, the expected return from a particular site will depend more heavily upon unit input costs. If the investment is intended to serve the local market, then the size and openness of the market will be of significance. The stage of the product's life cycle, as between a new, mature or standardised commodity may also be of significance. Locations with lower input costs are important when the product is standardised. One or a combination of these factors may tip the balance and encourage a firm to locate production facilities in a particular country.

10.3.2 Macro-determinants of FDI The macro-determinants of FDI are the factors that influence profitability and the choice to invest at an economy-wide level. These are the size and growth of the host market and factor prices. Factor prices are in turn influenced by tariffs and taxes. Thus there is much of an overlap with the micro-determinants of FDI, though the emphasis here is on the influence that the general macroeconomic environment has on FDI flows. The effects of the macro-environment are also reflected in a number of additional determinants of FDI. These include openness and export orientation, exchange rates, the inflation rate, budget deficit, domestic investment as well as political risk.

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Openness and Exports There are number of arguments linking openness, and exports, and FDI flows. The tariff-hopping hypothesis described in the previous section posits that there is a negative relationship between openness and FDI. Closed economies receive FDI, which is substituting trade. The opposing view is that outward-orientated economies are more successful at attracting FDI. The pressure of international competition makes for higher productivity. An outward-orientated economy is also not handicapped by the size of its domestic economy when attracting FDI - it offers efficiency and access to world markets. Empirical studies of whether a host country's export orientation may be important for attracting FDI flows find in favour of openness. Lucas (1993) finds that in Southeast Asian countries FDI is more elastic with respect to the demand for exports, than with respect to the aggregate domestic demand. Jun and Singh (1996) states that exports should be included as a control variable because of the higher export propensity of foreign affiliates. They find a particularly strong relationship between exports in general, and manufacturing exports in particular, and FDI. One should however note that the empirical literature raises a causation question whether FDI flows are attracted to economies that are export orientated or whether FDI leads to increases in exports. Jun and Singh (1996) argues that the relationship is likely to be simultaneous, with current results supporting the general notion that exports precede FDI.

Exchange Rates Related to openness is the importance of exchange rates as a determinant of FDIflowsto host economies. There are broadly two lines of thought concerned with the significance of exchange rates as a determinant of FDI: the currency area hypothesis and considerations of exchange rate risk. The currency area hypothesis argues that firms from harder currency areas are able to borrow at lower costs, and to capitalise the earnings on their FDI in softer currency areas at higher rates, than the local firms. The higher the share of capital value added and the size of the premium on the local currency, the greater the comparative advantage which foreign investors enjoy over local firms and that attracts FDI. The second line of argumentation takes account of the exchange rate risk to which TNCs are exposed when undertaking FDI and how that influences the decision to locate in a particular country. The nature of the risk firstly depends on the TNCs' activities in the host country. If the

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•

Inflation Rates Where the exchange rate reflects external economic balance or imbalance, the inflation rate is an indicator of a country's internal macroeconomic stability. Increased instability adds to uncertainty and makes investment unattractive. A high rate of inflation is a sign of internal economic tension and the inability or unwillingness of the government and the central bank to balance the budget and to restrict money supply (Schneider & Frey, 1985). This increases uncertainty regarding the business environment. Inflation also increases the cost of production (Urata & Kawai, 2000). Consequently it has a negative impact on FDIflows.This is confirmed by Schneider and Frey (1985), Yung et al. (2000) and Urata and Kawai (2000). Budget Deficits The budget deficit is similarly related to uncertainty and the choice to invest. A high or increasing budget deficit is not a host country characteristic that encourages FDI flows. It is more likely to cause uncertainty regarding the sustainability of the host government's fiscal stance and about what that may imply for the cost and profitability of investment. Empirical work by Chaudhuri and Srivastava (1999) supports a negative and significant relationship between budget deficits and FDI flows.

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Investment and Infrastructure FDI supplements domestic capital but it may be argued that the causation also runs the other way: domestic investment crowds in FDI. It does so by increasing productive capacity (Chaudhuri & Srivastava, 1999). In the same way infrastructure creates an enabling environment for foreign investors. It increases productivity and reduces the cost of production, which draws in FDI. Empirical results from Wheeler and Mody (1992), Cheng and Kwan (2000) as well as Urata and Kawai (2000) confirm this relationship.

•

Political Instability Political instability embodies a variety of concerns, ranging from production disruption to confiscation or damage to property, to threats to personnel, to a change in macroeconomic management or the regulatory environment (Lucas, 1993). Political instability is expected to decrease FDI because it increases uncertainty about the cost and profitability of investment. McMillan (1995) notes that stability may not however have the opposite positive effects. It adds to a general feeling of investment security, but does not have the specific "pull" as strong as that created by market forces.

10.3.3 Empirical Evidence Empirical studies produce mixed results on the determinants of FDI. Wang and Swain (1997) find that evidence from surveys of TNCs and their executives support a negative correlation between FDI flows and political instability. Evidence from cross-section studies, on the other hand, shows that political variables are of minimum concern to investors and are generally given the same treatment in FDI decisions as in domestic investment decisions. Recently many African countries, including South Africa have taken steps to attract FDI by improving their policy frameworks. Efforts include reforms aimed at increasing the role of the private sector in the economy, for example through privatisation. There are also steps taken to ensure and maintain macroeconomic stability, such as devaluation of overvalued currencies and the reduction of inflation rates and budget deficits. African countries are improving their regulatory frameworks for FDI - some 26 of the 32 least developed countries in Africa, surveyed by UNCTAD in 1997, have a liberal or relatively liberal regime for the repatriation of dividends and capital (UNCTAD, 1998). Progress is also being made with trade liberalisation, as well as the strengthening of the rule of law, and improvements in legal and other institutions that matter for the FDI climate. Finally, many African countries are establishing

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investment promotion agencies and have concluded bilateral investment and double taxation treaties that contribute to the creation of a more secure environment for foreign investors on the continent (UNCTAD, 1995). Though, as the statistics have shown, there has only been limited success in attracting FDI both in Africa generally and South Africa. In the next section we will argue that not enough emphasis have been placed on human resource development as a strategy in itself to attract FDI. The lack of proper and appropriate human resources may therefore be the an important factor currently limiting the flow of FDI to Africa and South Africa.

10.4 HUMAN RESOURCE DEVELOPMENT AS DETERMINANT OF FDI In the previous section we had discussed all of the standard textbook determinants of FDI. Governments and their IPAs in designing strategies to attract FDI usually address these determinants. However, we have argued with reference to both empirical econometric studies and the practical experience of South Africa and many other African countries that these determinants may be at most necessary but not sufficient conditions for attracting FDI. Therefore, in this section we argue that the level of human resource development in a country may be a sine qua non for FDI. The traditional neo-classical growth theory of the Solow (1956, 1957), Swan (1956) type regarded technological progress as exogenously given. Technologies are equally available without costs in every country. As a result global convergence is predicted. Countries are expected to converge in per capita income terms to steady states determined by the rate of technological progress, savings and population growth. Testing the traditional Solow model Mankiw, Romer and Weil (1992) found that the effects of the saving rate and population growth are overestimated. Further, the traditional model is not able to explain observable differences in the level and growth rate of income across countries unless unreasonably high capital shares are used. Thus, the predictions of traditional neo-classical growth theory do not correspond with the stylized features of the global growth process. Therefore, Mankiw, Romer and Weil (1992) introduced a new interpretation. They augmented the standard Solow model by including accumulation of human capital. The idea to include human capital is not new. Kendrick (1976) estimated that more than half of the total capital stock of the USA in 1969 consisted of human capital. Introducing human capital Mankiw, Romer and Weil (1992) show that the extended model provides a good explanation of the differences in the countries economic performance. Due to human capital the impact of the saving and population growth rate decrease. Or, to be

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more precise, if human capital accumulation is included and countries have different rates of accumulation and population growth, the implications of this extended Solow model cannot be rejected easily by the empirical facts. The key factor in the "new growth theory" is human capital. But unlike in the extended versions of the traditional theory, human capital is not just accumulated. The new growth theory has identified human capital as an important factor that induces positive externalities, scale economies and innovations. On aggregate spill overs between firms and the multiple uses of techniques and skills in different fields give human capital almost the character of a public good. These positive externalities affect the production processes and generate increasing returns to scale at the aggregate level. With some special additional assumptions about the production of human capital or the creation of new technological knowledge, these models can generate endogenous growth processes. Technological progress is now endogenously generated. While a model of endogenous growth was first suggested by Uzawa (1965) the idea of human capital externalities was developed by Romer (1986, 1990a, 1990b), Lucas (1988) and extended and modified by Azariadis and Drazen (1990), King and Rebelo (1990), Rebelo (1991), Grossman and Helpman (1991b) and others. Several causes for increasing returns to scale have been introduced (Backus, Kehoe and Kehoe (1992)). For instance Arrow's learning by doing (Arrow (1962)) was used by Lucas (1988, ch.5) and Young (1991). The role of R&D or education as a source of endogenous growth, was suggested by Lucas (1988), Stockey (1991) or Romer (1987, 1990a,b), Grossman and Helpman (1991b) as well as Aghion and Howitt (1992).

10.5 CONCLUSIONS We started this chapter by claiming that FDI is important in that it can augment a country's investment capital and foreign exchange earnings and so lead to higher economic growth. Moreover, given that the bulk of FDI is through Transnational Corporations, it becomes the mechanism through which the world economy is integrated into a global village. Currently annual FDI flows exceed US$ 1 billion. The problem facing South Africa and Africa is the very small trickle of FDI that flows towards them. Less than 2% of all FDI flows go towards Africa, and over the past few years South Africa had experienced disappointing and erratic inflows of FDI. The theoretical determinants of FDI were discussed in section 3 because these typically form the basis from which countries and the IPAs design investortargeting strategies. However we showed that these determinants are only necessary but not sufficient conditions, as both econometric studies and the experiences of many African countries (including South Africa) with strate-

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gies based on these could not explain adequately the poor FDI flows into South Africa. Based on theoretical considerations of the new growth theory we concluded in section 4 that human resources may be an important - if not sufficient - condition to explain the lack of FDI into South Africa and Africa. The new growth theory has identified human capital as an important factor that induces positive externalities, scale economies and innovations. The question know remains: how is South Africa's human resources inadequate - if at all - in terms of the requirements of potential foreign investors. To answer this question we must briefly look at the type of labour, type of skills that are current demanded. In the analysis we will point out that a fundamental reason for South Africa's slow growth, high unemployment and lack of sufficient FDI may be due to the fact that the supply of adequately trained labour has not kept up with the demand. Firstly, skills are at a premium. According to figures presented by Bhorat (1999:3) the growth in employment of professionals and administrative works (high-skilled workers) grew by over 300% between 1970 and 1995. In comparison, the demand for production workers and agricultural workers (low skilled) declined, by as much as 54% in case of the latter. This trend is consistent with observations made in South Africa that demand for high-skilled workers have increased, to the disadvantage of unskilled jobs. The growth in demand for higher-skilled workers is consistent with the growth in the services/tertiary sector in South Africa. Bhorat (1999:5) states -significantly- in this regard that "it cannot be doubted that the onset of the micro electronics revolution, epitomised by greater computer usage, has spurred on this preference within services for higher skilled individuals. The fact that the capital-labour ratios in the service sectors rose by as much as 117% strongly supports this notion". Since 1994 both changes in technology and the country's integration into the world economy has had two important consequences for the structure of the South African economy7. Firstly, it caused a shift in the sectoral composition in the economy towards service sectors. Secondly it caused a higher average skill requirement within sectors. The share of highly skilled and skilled workers increased from 38% in 1970 to over 57% in 1997/1998 whilst the share of unskilled workers declined over the same period from 62% to 43%. Both of these effects or consequences are reflected in the decline in employment (because of the lower demand for low skilled labour), increasing amount of capital per worker (representing "embodied technology") and increased output per 7

The opening up of the South African economy since 1994 had made technological upgrading an essential response to the need for greater competitiveness in the international market place.

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worker. We have shown in section 3 that TNCs have found skill intensive sectors such as transport and transport equipment, telecommunications and information infrastructure to be preferable sectors for investment. The increases in demand for skilled labour indicated in the figures quoted in the previous paragraph had overtaken the South African economy's supply thereof. Indeed South Africa's poor quality of people is perhaps the foremost factor that lowers its competitiveness. As measured by the IMD's World Competitiveness Report, the quality of people is measured by looking at the labour productivity, literacy rate, and skills. Let us briefly consider each of this in turn. Regarding productivity: since 1995, although labour productivity (as measured by GDP per employee) grew by 2.5% per annum on average, this was still substantially lower than that of South Africa's main competitors, particularly the NICs of the East such as Taiwan, (4.7%), Korea (4.51%), Hong Kong (3.7%) and Singapore (3.0%). Labour productivity is closely linked to unit labour costs (which is a measure of both changes in the amount of labour used in the production process, as well as charges in the price of labour). Particularly in manufacturing, rising unit labour costs had resulted in slower increases in labour productivity in South Africa than many other countries. It has been and still is a factor that impinges negatively on South African firms' capacity to compete in international markets on the basis of price. Between 1972 and 1990, for instance, labour productivity in South Africa's manufacturing grew by only 0.9% on average annually, compared to 9.7% in China, 7.6% in Indonesia, 8.2% in Korea, 5.9% in Taiwan, etc. By 1993 the manufacturing earnings in South Africa were US$ 9088 per annum, compared to a much lower labour cost of US$656 in China, for instance. Neighbouring countries such as Botswana (US$3311) and Zimbabwe ($3550), also offers cheaper labour than South Africa. It would be futile for South Africa to compete only on the basis of labour costs with these countries, or attempt to follow the approach of the current NICs and base export-manufacturing strategy on cheap labour. South African manufacturing firms, especially in labour-intensive sectors such as food processing, footwear, textiles, furniture, etc., would thus have to remain competitive despite relatively high labour costs. This requires higher labour productivity, through application of high-technology, automation and the like, and of finding ways by which to keep distribution costs as low as possible. These factors imply amongst others that: •

Highly-skilled workers will be in demand and that the demand for unskilled workers will decline further.

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Regarding literacy and skills, the lack of highly skilled labour is particularly problematic in South Africa. The following aspects will serve to argue that it is this lack of sufficiently and appropriately skilled labour, exacerbated by the so-called brain drain that is currently one of the most significant constraints on FDI in South Africa. • • • • •

•

•

The science and engineering workforce of the country had declined from 3.6% of the total workforce in 1992 to currently less than 2%. The enrolment in science and engineering courses declined from 19% in 1985 to 16% in 1997. Estimates of emigration from South Africa over the period 1989-1997 amounts to over 200 000. Immigration laws and procedures, especially towards temporary migration of skilled labour, is restrictive and seriously hampers South Africa's ability to source appropriately skilled labour from abroad. A survey of 800 small businesses in the Greater Johannesburg Area (GJA) found that between 30% and 40% reported a skills shortage in 1999. Despite this shortage SME training expenditure declined from an average of R1700 per employee per annum in 1997 to R400 per annum per employee in 1999(Chandra et at, 2001b:iv). Large firms faced a similar problem but in the IT sector 53.8% of all firms had difficulty to find skilled labour. The National Enterprise Survey (NES) conducted in 1999 by the President's Office found that the most significant obstacle to further investment in the producer services sector is lack of access to skilled human capital. It is especially this sector that is most severely affected by the "brain drain": according to a survey by SAITIS (1999) in 1998 31% of IT managers, 29% of programmers and 23% of system analysts left South Africa that year. A survey by ITWweb in 1999 further found that 48% of respondents were likely or very likely to leave the country within the next two years. According to Cisco Systems the local skills shortage in IT is forecasted to rise from 33% in 1999 to 62% in 2003.

In addition to the above, South Africa's Human Sciences Research Council (HSRC)8 has recent completed a study on labour market trends and workforce needs in respect of formal employment for 1998 to 2003. The results are not very optimistic. In fact, it suggests that fewer than 50 000 jobs9 will be created over the next five years, despite the estimated economic growth rate of 2.7%. Jobless growth seems to be a set feature over the next five years. Most job losses will be in semi-skilled and unskilled occupational categories, and 8

HSRC, 1999: SA Labour Market Trends and Future Workforce Needs. It must be borne in mind that about 250 000 new jobs (in net terms) must be created annually in South Africa simply to ensure unemployment does not rise. Ideally, 350 000 should be created. 9

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the HSRC predicts that the highest growth of job creation will be in the field of information technology (IT), chartered accountancy, engineers (electrical & chemical). Employment is predicted to decline in four sectors, namely mining, manufacturing, electricity and services), increase in three (construction, trade and finance) and stay constant in transport and communications. The above are all indications that a shortage of skills in precisely those sectors that are currently growing in the global economy (services, IT & high-tech manufacturing) may be lacking in South Africa. The context in which South Africa will have to address these shortages contains two challenges10 (Van der Berg, 2001:175-177). First, the quality of education varies significantly - most former African schools perform much more poorly than white schools, and in 1998 only 13% of matriculants received university exemption. Secondly, the standards of education and subject choice remain problematic - mathematics and science are severely neglected. For instance only 45% of all matriculation candidates in 1997 wrote mathematics and only 21% passed. We can now conclude with some recommendations for a human resource development policy for South Africa that will facilitate the efforts by the government and its IPAs to attract FDI. Firstly, both physical and human capital is important and government programs must recognise this complementarity in developing human resources. In a survey on human capital Hamermesh (1986) states: "Perhaps the most consistent finding is that non production workers (presumable skilled labour) are less easily substitutable for physical capital than are production workers (unskilled labour). Indeed, a number of the studies find that non-production workers and physical capital are p-complements. Therefore Fagerberg (1994) concludes that countries should not invest in either education or physical capital, but in both assets.

10

Considering the extent of human capital and fixed investment in South Africa and Africa, it is firstly clear, from public expenditure data, that public investment in human capital, as a share of potentially productive government expenditure to GDP, is high in Africa and South Africa. Provinces already spend 85% of their budgets on social expenditure including education, health and welfare. It would thus appear that the provision of education services has not been markedly worse than elsewhere. However, in many cases in Africa and South Africa the implementation of education policies is deficient. Clearly in South Africa the legacy of apartheid is most keenly felt in the lack of adequately skilled labour.

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Secondly, it is imperative that South Africa's "Brain Drain" be reversed. The New Partnership for Africa's Development (NEPAD - see www.nepad.com) recognises the importance for the whole of Africa in stemming the tide of skilled migrants by for instance provide greater safety and security and reducing crime. The latter is consistently found as a significant determinant of emigration. Thirdly is it clear that South Africa should adopt a less restrictive policy on the recruitment and immigration of temporary skilled workers from abroad. Fourthly, the orientation of our education system towards greater emphasis on science and mathematics and on improving the quality of education throughout, are steps in the right direction. This will only be fruitful if the system is oriented more strongly towards needs of industry (demand driven) and if firms take on more responsibility for training of workers. The Skills Development Act is consistent with these recommendations. Finally, although space limitations precluded an analysis of the impact of the HIV/AIDS pandemic on FDI, it can be concluded that if human resources are an important determinant of FDI, then any situation that negatively affects a country's stock of skilled human capital will negatively impact on FDI. Thus like violent crime, HIV/AIDS not only makes it more expensive to create a job, but it also makes the investment in human capital (through training and efficiency wages) more risky. Understanding this link might explain why Sub-Saharan Africa, the region of the world with the highest incidence of HIV/AIDS, is also the region that attracts the smallest amounts of FDI. Addressing HV/AIDS is therefore a crucial component of any human resource development strategy for FDI.

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Lucas, R. (1988). On the Mechanics of Economic Development, Journal of Monetary Economics, 22: 3-42. Lucas, R. (1993) On the determinants of foreign direct investment: Evidence from east and south-east Asia. World Development, 21. pp. 391-406 Madison, A. (1987). Growth and Slowdown in Advanced Capitalist Economies, Techniques of Quantitative Assessment, Journal of Economic Literature, 25: 649-98. Mahlo, I. (1986). Theories of Migration: A Review, Scottish Journal of Political Economy, 33: 396-419. Mankiw, N. G. (1995). The Growth of Nations, Brookings Papers on Economic Activity, 275-326. Mankiw, G., Romer, D., Weil, D. (1992). A Contribution to the Empirics of Economic Growth, Quarterly Journal of Economics, 107: 407-37. Mcmillan, S. (1995) Foreign direct investment in Ghana and Cote d'lvore, in: Chan, S. ed. Foreign direct investment in a changing global political economy. New York: St. Martin's Press, p. 150-165 Michaely, M.M. (1977). Exports and Growth: An Empirical Investigation, Journal of Development Economics, 4 (1): 49-53. Moschos, D. (1989). Export Expansion, growth and the level of economic development. Journal of Developing Economics, 30: 93-102. Murphy, K. M., Schleifer, H., Vishny, R. W. (1989a). Income Distribution, Market Size and Industrialization, Quarterly Journal of Economics, 104: 537564. Murphy, K. M., Schleifer, H., Vishny, R. W. (1989b). Industrialization and the Big Push, Journal of Political Economy, 97: 1003-1026. Naude, W. A. (2001). Shipping Costs and South Africa's Export Potential: An Econometric Analysis, South African Journal of Economics, 69(1) : 123-146. Ng, F., Yeats, A. (1996). Open economies work better! Did Africa's protectionist policies cause its marginalisation in world trade? World Bank Policy Research Working Paper, 1636.

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Ng, F., Yeats, A. (1998). Good governance and trade policy. Are they the keys to Africa's global integration and growth? World Bank trade research team. OECD (1996). The OECD Jobs Strategy; Technology, Productivity and Job Creation; Vol. 2: Analytical Report. Paris: Organization for Economic CoOperation and Development. Przewoski, A., Limongi, F. (1993). Political Regimes and Economic Growth, Journal of Economic Perspectives, 7: 51-69. Ram, R. 1985. Exports and economic growth: Some additional evidence. Economic Development and Cultural Change, 33, 415-425. Ram, R. 1987. Exports and economic growth in developing countries: Evidence from time-series and cross-section data. Economic development and Cultural Change, 36, 51-72. Rebelo, S. (1991). Long-Run Policy Analysis and Long-Run Growth, Journal of Political Economy, 99:500-521. Rivera-Batiz, L.A., Romer, P.M. (1991a). International Trade with Endogenous Technological Change, European Economic Review, 35: 971-1004. Rivera-Batiz, L. A., Romer, P. M. (1991b). Economic Integration and Endogenous Growth, Quarterly Journal of Economics, 106: 531-555. Rivera-Batiz, L. A. and Xie, D. (1992). GATT, Trade and Growth, American Economic Review, 82: 422-427. Rivera-Batiz, L. A. and Xie, D. (1993). Integration among Unequals, Regional Science and Urban Economics, 23: 337-354. Rodriguez, F., Rodrik, D. (1999). Trade policy and economic growth: A sceptic's guide to the cross-national evidence. Discussion Paper Series: Centre for Economic Policy Research, 2143. Rodrik, D. (1998). Trade policy and economic performance in sub-Saharan Africa. NBER Working Paper Series, 6562. Romer, P. M. (1986). Increasing Returns and Long-Run Growth, Journal of Political Economy, 94 (5): 1002-1037. Romer, P. M. (1987). Growth Based on Increasing Returns due to Specialization, American Economic Review, 77: 56-62.

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Romer, P. M. (1990a). Endogenous Technological Change, Journal of Political Economy, 98: 71-102. Romer, P. M. (1990b). Are Nonconvexities Important for Understanding Growth? American Economic Review, 80 (2): 97-103. Romer, P. M. (1990c). Capital, Labor and Productivity, Brooking Papers of Economic Activities: Microeconomics, Special Issue, 337-67. Rosen, S. (1968). Short Run Employment Variation on Class I Railroads in the United States, 1947-1968, Econometrica, 36: 425-431. Quah, D. (1993). Empirical cross-section dynamics in economic growth, European Economic Review, 37: 426-34. Quah, D. (1996). Empirics for economic growth and convergence, European Economic Review, 40: 1353-75. Sachs, J.D., Warner, M. (1995). Economic Reform and the Process of Global Integration, Journal of African Economies, 6: 335-376. Sala-I-Martin, X. (1996). Regional cohesion: Evidence and theories of regional growth and convergence, European Economic Review, 40: 1325-52. Shaw, K. L. (1991). The Influence of Human Capital Investment on Migration and Industry Change, Journal of Regional Science, 31:397-416. Schneider, F. and Prey, B.S. (1985) Economic and political determinants of foreign direct investment. World Development, 13. pp. 161-175 Soete, L., Verspagen, B. (1993). Technology and Growth: The Complex Dynamics of Catching-Up, Falling Behind and Taking Over, in: Szirmai, A. et al. Explaining Economic Growth, Essays in Honour of Angus Maddison, pp. 101-128. Solow, R. (1956). A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, 70 (1): 65-94. Solow, R. (1957). Technical Change and the Aggregate Production Function, Review of Economics and Statistics, 39: 312-320. Stockey, N. L. (1991). Human Capital, Product Quality, and Growth, Quarterly Journal of Economics, 106: 587-616. Summers, R., Heston, A. (1994). The Penn World Table (Mark 5.6)

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Swan, T. W. (1956). Economic Growth and Capital Accumulation, Economic Record, 32: 334-361. Teal, F. (1999). Why can Mauritius export manufactures and Ghana not? Working Paper Series: Centre for the Study of African Economies, 99/10. Tiebout, C. M. (1956). A Pure Theory of Local Expandages, Journal of Political Economy, 64: 416-424. Tyler, W.G. (1981). Growth and export expansion in developing countries: Some empirical evidence. Journal of Development Economics, 9: 125-141. United Nations (1995). Sectoral flows of foreign direct investment in Asia and the Pacific. ESCAP studies in trade and development. No. 5. New York: United Nations, p. 17-25 United Nations Conference on Trade and Development (1995). Foreign direct investment in Africa. Division on transnational corporations and investment. Current studies, Series A, No. 28. New York: United Nations. United Nations Conference on Trade and Development (1998). Foreign direct investment in Africa: Performance and Potential. New York. United Nations Urata, S. and Kawai, H. (2000) The determinants of the location of foreign direct investment by Japanese small and medium-sized enterprises. Small Business Economics, 15. pp. 79-103. Uzawa, H. (1965). Optimum Technical Change in an Aggregative Model of Economic Growth, International Economic Review, 6: 18-31. Veblen, T. (1915). Imperial Germany and the Industrial Revolution. London. Venables, A.J. (1996). Trade policy, cumulative causation and industrial development. Journal of Development Economics, 49:179-197. Verspagen, B. (1991). A New Empirical Approach to Catching-Up or Falling Behind, Structural Change and Economic Dynamics, 2 (2): 359-80. Verspagen, B. and Wakelin, K. (1993). International Competitiveness and Its Determinants, MERIT Working Paper 93-008, Maastricht, Netherlands. Veugelers, R. (1991). Locational determinants and the ranking of host countries: An empirical assessment. Kyklos, 44. pp. 363-382.

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11 CONCLUSIONS B. M. GILROY1, T. GRIES2, and W. NAUDE3 1 2 3

University of Paderborn, Germany University of Paderborn, Germany North-West University, South Africa

In the introduction to this book we stated that we proceed from the standpoint that Africa needs much greater investment by multinational enterprises (MNEs) to improve its competitiveness, to develop its comparative advantages and fast-track growth through the positive spill-over effects associated with the activities of global firms. We can now come back to the question that we had posed in that chapter namely to identify why and how African countries can become a more desirable destination for MNEs? In Chapter 1 by Thomas Gries & Willem Naude entitled "On Global Economic Growth and the Challenge Facing Africa" the economic development challenge facing African governments in a globalising world economy was set out. The chapter applied the insights from the "endogenous growth" literature and empirical findings from the literature on Africa's economic performance to establish that Africa requires investment by multinational enterprises (MNEs) to improve its competitiveness and to facilitate micro-level structural changes required to reduce its riskiness as an investment environment. The authors noted that in the debate on the strategies open to African countries to speed up economic growth, the role and nature of MNEs and FDI is relatively understated. The authors emphasised that the importance of MNEs in economic globalisation is due to their functions in providing Foreign Direct investment (FDI) and of leading to growing intra-firm trade. Although African countries remain amongst the most "closed" economies in the world, many have begun to implement trade liberalisation programmes and adopted outward-orientation as a growth. FDI and the benefits of intra-firm trade, given that international technology transfer is primarily in the form of intrafirm deals, may thus hold significant growth-benefits to Africa as a whole. Rising FDI and involvement of MNEs could stimulate economic growth in Africa to the extent that it facilitates micro-economic, structural changes required for the African economic environment to become more "investment friendly". It is the type of benefits that FDI and MNEs could impart that could be

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beneficial in this regard to Africa within a global economy, namely technology spillovers, international technology trade, improved use of know-how and a higher overall investment-output ratio. Hence, the authors conclude, Africa might be in low-growth equilibrium trap, unless factors and conditions can be identified whereby MNEs can become more involved in African economies. In Chapter 2, entitled Catching- Up, Falling Behind and the Role of FDIs Thomas Gries introduced a theoretical model that may give an idea of the major development mechanisms as well as the effects of the domestic factors and FDIs on the catching-up process. The theoretical model of this chapter attempts to overcome three challenges in the traditional modelling FDI. Firstly the model includes a stylized development mechanism, which captures the empirical observed regimes of catching-up as well as falling-behind. That is, the model should allow identifying the conditions for a switch from stagnation to dynamic upgrading. Secondly the model clearly distinguishes between the contributions of domestic factors and external factors on growth and development. Thirdly the model is able to identify the effects of FDIs on the development process and draw a general picture of the potential role of FDIs for development. The implications from the model show that a typical African economy will face a divergence regime as long as human capital endowments are below a critical level. Although FDI is important for the process of catching-up the switching condition for upgrading as well as the national level of the technological position is solely determined by the stock of domestic human capital. Without a sufficient domestic factor, no take off to a dynamic catching-up process takes place. Therefore the results in this chapter emphasize the importance of the domestic human capital. Gries further show that once having reached a critical level of human capital, the process of upgrading towards the industrialized world is not linear, but s-shaped. Successful catching-up requires the closing of the technological gap towards the leading countries of the industrialized world. In this respect FDIs are indeed important for the level and speed of GDP growth. A decreasing level of FDIs will reduce the path as well as the steady-state income level of the economy. Having detailed the catching-up challenge facing Africa and having shown that FDI can, conditionally, help African countries to catch up, chapter 3, by Waldo Krugell focuses on "The Determinants of FDI in Africa". The main contributions to the theory of FDI and an overview of recent empirical work are presented. Hypotheses of the determinants of FDI in Africa are tested in a pooled cross-country and time series model of 17 countries in sub-Saharan Africa for the period 1980 to 1999. Past FDI flows, GDP growth and domestic investment are found to be positively and significantly related to FDI flows. Inflation is negatively related to FDI. Conflicting results are found for the importance of the openness of the economy, as a determinant of FDI. The

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latter result may be explained with regard to the form and sequencing of trade liberalisation, however the cross-sectional econometric analysis suffers from insufficient data to test this. However, African countries have been increasingly moving to openness through regional integration. Given that most studies on regional integration in Africa focuses on regional integration within or between African countries, in chapter 4 Willem Naude, Waldo Krugell and Norbert Bauer studied the "The Global Integration of Africa: The EUSA Free Trade Agreement and German MNEs in South Africa". This chapter therefore critically assessed, from an economic point of view, the potential of regional economic integration amongst African countries for promoting economic development and economic convergence of Africa by leading to greater "openness". The authors considered the recent explanations for Africa's poor economic development and assessed the African experience with regional integration. They found that integration amongst African states may be suboptimal to integration between African states and a higher income region (e.g. the EU) and that regional cooperation in terms of economic policy and political stability may be vital in the face of significant neighbourhood effects on economic growth. The contribution of this chapter was to call on African states to focus on economic integration with countries outside of Africa for openness that will lead to an expansion of trade and for obtaining technology and investment as identified in the model of Gries in chapter two. In this, the chapter sounds a positive note on the advantages of globalisation for African economic development. The advantage of regional integration amongst African countries is seen to be in its potential to enhance economic policy coordination and the adoption of sound macro-economic policies and governance practices. It is hoped that by opening up their economies African countries can attract greater volumes of FDI, given their human capital resources. The main vehicle for FDI is the Multinational Enterprise (MNE). It has often been the case that the activities (and/or motives) of MNEs have been questioned in public debates. Therefore in chapter 5, Michael Gilroy described with reference to the basic theoretical models to explain MNEs, "The Changing View of Multinational Enterprises and Africa". Gilroy showed that the business activities of MNEs, now numbering some 63000 parent firms with around 690000 foreign affiliates and a plethora of inter-firm arrangements and collaborations, spans virtually all countries and economic activities, making international business knowledge a growing necessity even for small and medium sized business enterprises. Gilroy stress that many of the activities which are so essential for the success of the new world order implies that African growth through regional integration must be carried out by the private sector, specifically the MNE. In this chapter Gilroy provided a thorough description of the enormous literature on the institutional phenomenon of MNE and the rapid evolutionary

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changes in the understanding of MNEs throughout the years. He critically evaluated the significant theoretical contributions in the areas of international trade, industrial organisation, international finance, transaction-cost approach to economic organisation, business administration, taxation, and elements of law and political science that have all been successfully applied to the domain of multinational enterprise analysis. One of Gilroy's main findings is that the important advantage of MNEs for Africa, as differentiated from a national corporation, may lie in their flexibility to transfer economic resources, information, knowledge and ideas internationally through a globally (or at least regionally) maximising network which offer an almost infinite variety of transactional options. Up until the end of chapter five this book focussed on the theoretical and empirical aspects and broad explanations for FDI inflows and MNE behaviour into Africa. The various chapters made a case for FDI as mechanism for Africa to catch-up. It pointed to the importance of human capital and openness (through regional integration with higher-income countries) to attract more FDI and argued that investment by MNEs (through FDI) have important advantages above domestic investment that will be required by African countries to fast track economic growth. From chapter 6 to 8 the focus narrowed, first to German MNEs in Africa and then to an analysis of what constrains the operations of German MNEs in South Africa. For instance in chapter 6, by Michael Gilroy and Norbert Bauer the focus was on "German Multinationals in Africa". The main aim of this chapter was to examine the historical background and influences of colonialism upon the international production strategies of MNEs in Africa with a special focus on German MNEs and their activities in South Africa. They found that the internationalisation of German MNEs in Africa is driven by three motifs. First, firms have merged, purchased or set up foreign production to secure foreign markets for their commodities. Secondly they follow a strategy of securing raw materials in foreign markets for the production process in the home country. Lastly, the increasing intra-firm division of labour generated cost differences. Indeed as they identify, German companies are aware of the fact that South Africa is highly profitable in labour-intensive production. From 1997 until 1999 German FDI in South Africa increased from 733 million DM to 1202 million DM. The authors' found that this amount accounts for almost 44 percent of overall German outward flows to developing countries. German MNEs clearly have an important role to play in South Africa. The authors found that German MNEs have a traditionally long relationship with South Africa. They are familiar with its environment and market climate and have also overcome the rigid system of separation. According to Gilroy and Bauer the perception of German MNEs in South Africa can more or less be projected onto other European companies in South Africa.

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In Chapter 7, Willem Naude, Thomas Gries, Michael Gilroy and Karl-Heinz Schmidt investigated the "Obstacles Facing German Enterprises in South Africa" from a survey of the 600 German firms belonging to the SA-German Chamber of Business. From the analysis of the findings of this survey the authors concluded that German MNEs have an important role in South Africa in terms of significant employment that is directly generated. However, it seems that these firms are experiencing severe constraints as is reflected in the high rate (almost a third) of firms considering to leave South Africa or disinvest, the negative view of the adequacy of labour and concerns over educational standards, and concerns about crime, violence, corruption and the incompetence of civil servants. Indeed it was found that the position of many German MNEs in South Africa is tenuous. Not many companies engage in exporting and it seems the reason for German MNE presence in South Africa is to serve the domestic market. In the latter regard their constraints seem to reside in the labour market and uncertain macro-economic environment. As such German MNEs have not been creating significant new job opportunities, despite increasing investments in R&D activities advancements in technology. A lack of skills and concern about educational standard were expressed by firms and most prefer to train their workers in Germany. Investment by German firms in South Africa (with notable single exceptions) seems to be stagnating (despite rising profits) and most firms see a worsening of crime, inflation and expect further depreciation of the Rand. The linkages between labour market failures, inadequate human capital and crime and FDI was further taken up in chapter 10. Chapter 8 dealt with "Competitive Intelligence in a Foreign Environment: German and Canadian Firms Compared" and is by Jonathan Calof and Wilma Viviers. Given the lengths of time that German MNEs have been operating - quite successfully in the African context - in South Africa, the authors aimed to find out whether the competitive intelligence practices of these German MNEs are as intense as one would expect in a high-risk, uncertain and foreign environment. The authors benchmark the German firms in South Africa to Canadian firms (operating in Canada). Taking into consideration the caveats in the comparison of these results (different size firms, different sectors and different time frame between all the comparative studies), the results indicated that German MNEs' CI efforts are indeed more advanced in terms of formality when contrasted to both Canadian and American firms. The final chapters of this book dealt with the labour market implications of FDI. The various final chapters considered the reasons why higher FDI might not create more employment, and how the adequacy of human capital can determine FDI.

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In Chapter 9 Thomas Gries and Stefan Jungblut considered a model to explain the "Employment Effects of Foreign Direct Investments: A Theoretical Analysis with Heterogenous Labour". High unemployment rates will be the most challenging problem for many African countries in the next decade. The chapter started out by noting that in South Africa as well as in almost all African countries the gap between the unemployment rates and/or wages for skilled and unskilled labour increased over the past two decades. While there is an extended literature on the effects of trade on employment, little is known about the effects of capital mobility and FDIs. Adopting the flow approach to labour markets, Gries and Jungblut presented a model of persistent structural unemployment. Two segments of the labour market in a typical African country were distinguished, one for skilled and one for unskilled workers. For each segment the long-term unemployment equilibrium was derived. Allowing for international capital mobility the authors analysed the effect of FDIs on relative factor prices, optimal factor allocation and the opportunity costs of vacancies in the different segments of the labour market. The main finding was that skilled labour would always gain from increasing FDIs while the effects for the unskilled is ambiguous. The ambiguous effect for unskilled is the result of a general positive effect of FDIs on aggregate employment and a negative reallocation affecting the unskilled: The negative effect can be reduced or even reversed if FDIs are complemented by policies like imports of foreign experts or additional human capital investments. It should be noted that chapter seven indicated some concerns by German MNEs in South Africa about the presence - or absence - of these factors. Therefore the final chapter, chapter 10 by Willem Naude and Waldo Krugell concluded with "Human Resource Development: A Sine Qua Non for FDI in Africa and South Africa?". In this chapter they argued that human resource development, especially strategies aimed at skills development in technical and professional occupations, and health care to ensure that labourers can have productive application in the economy, are indispensable if South Africa - and for that matter other African countries - wish to attract the levels of FDI it needs to achieve sufficient economic growth. They discussed the current levels of FDI into South Africa and then put forward the theoretical case for seeing human capital as a vital compliment to physical capital with reference to the model of Gries and Jungblut in chapter 9. They noted the current shortcomings in human capital in South Africa that might explain the inadequate FDI and local investment response since 1994 and made recommendations for a FDI friendly human resource development strategy for South Africa in particular and Africa in general.

APPENDIX

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A APPENDIX

UNIVERSITAT PADERBORN UNIVERSITY OF POTCHEFSTROOM SURVEY QUESTIONNAIRE

CONFIDENTIAL RESEARCH PROJECT: ENTREPRENEURIAL NETWORKS, HUMAN SKILLS AND MULTINATIONAL FIRMS IN LABOUR MARKET ADJUSTMENTS TO GLOBALISATION Faculty of Economic & Management Sciences, Potchefstroom University Private Bag X6001, POTCHEFSTROOM 2520 Tel Fax

(018) 299 1440 (018) 299 1360

The forms should be returned before 30 Nov. 2000 to the address above. A stamped, self-addressed envelope is included. NB! Please send a copy of your Group Annual Report for 1998 and 1999 (if available) Form A: Details of the company/group in Germany and its interests abroad. (Please read the instructions before filling in the questionnaire.)

A APPENDIX

SEC TION1: GENERAL QUESTIONNA [RE

1. 2.

Name of company: Contact person: Tel: Fax: Email:

3. 4.

5.

6.

7. 8. 9. 10. 11. 12.

13.

14.

Sector/Industry: Value of Group: a)Sales in 1998 ($) b)Sales in 1999 Value of S A company a)Sales in 1998 (R) b)Sales in 1999 Number of employees in S A in a) 1997 b)1998 c)1999 Date at which SA branch established: Number of production plants/facilities in SA: Location of head office in S A: Location of parent company's head office: Number of affiliates of parent company in world ('99) List most important products: a) b) c) d) Value of capital (plant,equipment & buildings) in (R) in a) 1998 b)1999 Profits/losses in (Rands) in a) 1998 b)1999

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UNICODE XX XX XX XX

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SEC TION2: LABOUR MARKET QUES TIONNAIRE 1.

Total number of employees in SA (1999) Number Male Number Female

2. 3.

4. 5. 6.

7. 8. 9. 10.

11.

12.

Number of expatriate employees in 1999 Number of days of strike action lost in a) 1997 b)1998 c)1999 % of labour force that are union members Number of females in labour force Total wage bill of SA company in a)1997 b)1998 c)1999 Do you have an Employment Equity Plan? (Y/N) Is high labour turnover a problem? (Y/N) Is suitably qualified labour available in South Africa? (Y/N) What are the major skills (occupations) required by your company? (List) a) b) c) d) e) Are labour market regulations restricting further investment by your company in SA? (Y/N) Are labour market regulations restricting further employment of local labour by your company in SA? (Y/N)

CODE

A APPENDIX

SEC riON 3: TECHNOLOGY QUESTION?JAIRE 1.

2.

3.

4.

5.

6.

7. 8.

9.

10.

Amount spent on research and development in SA in (R) a) 1997 b) 1998 c) 1999 Amount spent on R & D by whole GROUP in: ($) a) 1997 b) 1998 c) 1999 What % of South African sales is from a) products/services < 3 years old? b) products/services 4-10 years old? c) products/services > 10 years old What % of products/services in the GROUP is due to innovations in last 3 years? How many new jobs have been created in SA by technological innovations in a) 1997 b) 1998? c) 1999? How many jobs were terminated in SA by technological innovations in a) 1997? b)1998? c)1999? Are skills in SA appropriate for technology used? (Y/N) Amount spent on foreign licences and agreements in SA in ($) in: a) 1997 b) 1998 c) 1999 How many patents did your group own in a) 1997 b) 1998 c) 1999 % Of sales generated by SA company due to E-Commerce in a) 1997 b)1998 c)1999

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11.

12.

% Of sales generated by GROUP due to E-Commerce in a) 1997 b) 1998 c) 1999 Are IT & Communications Technical Business Support Services Adequate in SA? (Y/N)

SEC TION 4: TRAINING QUESTIONNAIRE 1.

2.

3. 4. 5. 6. 7. 8. 9.

10.

What % of your SA labour force is a) Low-skilled (< Std 8)? b) Medium skilled (< diploma)? c) Highly-skilled (degree)? Amount spent in Rands by SA company on training for employees in a) 1997 b) 1998 c) 1999 Do you send employees to Germany for training? (Y/N) Do you provide training for suppliers/clients? (Y/N) Are training & skills levels in SA adequate for your purposes? (Y/N) Does crime impact negatively on your company's sales? (Y/N) Is corruption & theft a significant problem in your company? What is the average monthly wage in Rands of your company in 1999? Does your organization experience problems in maintaining technical expertise? (Y/N) What does your organization do to retain good employees?

A APPENDIX

SEC TION 5: BUSINESS ENVIRONMEN r QUESTIONNAIRE 1.

2. 3. 4.

5.

6.

7.

8.

Please list the major constraints on your business' profitability in SA a) b) c) d) e) How many competitors do you face inSA? How many new competitors entered the market in the last year? How does your company finance investment? % From a) Retained earning? (%) b) Parent company? (%) c) Loans in SA? (%) d) Loans in Germany? (%) e) Overdraft? (%) 0 Equity? (%) What is your expectation of the level of the following indicators in 3 years' time (up/down/same) a) Inflation? b) Rand: $ exchange rate? c) level of import tariffs? d) Company tax rates? e) Crime? What amount did your company spend in SA on marketing in (R) a)1997 b)1998 c)1999 What was the value of your exports from SA (in $) in a) 1997? b) 1998? c) 1999? What are the major destinations of your exports from SA? a) b) c) d)

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SEC ITON6: NETWORKS 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

What value of your inputs are sourced from SA small enterprises in a)1998? b)1999? Do you have a procurement policy that favours small and micro enterprises? (Y/N) Have you been involved in technology transfer to suppliers and clients in SA in 1999? (Y/N) Have you brought SA companies in contact with other German companies in 1999? (Y/N) Have you outsourced functions of your company in SA over the past 3 years? (Y/N) Have you restructured or reengineered your company in SA over the past 3 years? (Y/N) Does your company office act as services centre for other African countries? (Y/N) How much has your company spent in SA on social responsibilities in a)1998? b)1999? Are your products/services in conformity with International Standards Organization (ISO) requirements? Are your company's plants and offices located in a business park? (Y/N) How significant a constraint is the current transport and logistical services in SA on your organization? Big constraint (5) Medium Constraint (4) Average constraint (3) Small Constraint (2) No constraint (1)

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Section 7: Competitive Intelligence Prior to completing the section, familiarise yourself with the following definitions of Competitive Intelligence as they form the basis of this section. Competitive Intelligence is: Timely and fact-based information on which management may rely in decision making and strategy development. CI may involve an industry analysis, which means understanding all the participants in an industry; competitive analysis, which is understanding the strengths and weaknesses of competitors; or benchmarking, which is the analysis of individual business processes and competitors. (Society of Competitive Intelligence Professionals) Competitive Intelligence is: Information which describes the competitiveness of a firm; understanding the competitive arena, predicting competitor's moves, customers moves, government moves and so forth (Gilad, 1994). Do your organization make use of competitive intelligence methods to gain information regarding your competitors? Yes No a) If yes, does your company have an organized unit/department - doing CI? Yes No b) If no, is CI integrated throughout the organization? Yes No If yes (question 1), which department/division is principally responsible for CI. Marketing Strategy/planning Corporate R+D Distribution CI unit Finance Manufacturing Other(indicate) How long has the unit/dept been in practice?

years

How many employees in your firm have a part-time or full-time CI responsibility? part time full time 6. How much access do CI personnel have to the president and/or CEO of the firm? Select one. 0 No access 1 Annual 2 Infrequent 3 Monthly 4 Weekly 5 Daily

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CI Gathering Intelligence can be gathered through various sources. Please use the following scale to indicate the importance of the following sources and how frequently you use it. For importance, please use the following scale: 0=Unimportant, l=Neutral, 2=lmportant, 3=Somewhat important, 4=Very Important For frequency, please use the following scale: 0=notused, l=Annual, 2=Monthly, 3=Weekly, 4=Daily

Information Source Archival (articles, reports, etc.) Associations Competitor's personnel Consultants (other than industry experts) Customers (foreign and domestic) Focus groups Government representatives in your country Government representatives in another country Internet Journalists Peers in other departments/divisions Peers in your department/division Subordinates Superiors (bosses) Suppliers Other

Frequency

Importance

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Dissemination (Distribution) The following question examines how you disseminate information. You are asked to indicate how frequently you use the specified dissemination methods and how important are they? For frequently, please enter a number between 0 and 4 using the following scale: 0=not used, 1= Annual, 2=Monthly, 3=Weekly, 4=Daily For importance, please use the following scale: 0=Unimportant, l=Neutral, 2=lmportant, 3=Somewhat important, 4=Very Important

Dissemination Method Customized reports Personal communication Memo Presentation Newsletter Intelligence seminar/meeting Intranet Retreat E-mail Bulletin boards Computer databases Fax Files

Frequency

Importance

Management and Organization The intelligence process involves planning the study, collecting and analyzing the information, disseminating and evaluating the entire project. When doing an intelligence project, how much time do you spend on each of these activities? Place the percentage of competitive intelligence time you spend on each activity. Note the column should total at 100% Intelligence activity Planning for the CI study Collecting information Analyzing the information Disseminating the results Evaluating the results of the CI study

% of your time

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Constraints Please assess the extent to which each problem currently hampers your CI efforts or prevents you from doing competitive intelligence 0=Not a problem, l=Somewhat a problem, 2=Medium Problem, 3=Major problem Problem area

Extent of problem

Top management commitment to the CI effort Legal issues Ethical issues Integrating CI in the organization Getting people in the organization to share information Number of CI personnel Internal politics Getting decision makers to use CI output Interaction with senior management Credibility among managers for CI Getting feedback from clients Budget Training Counter-intelligence Other

THANK YOU FOR YOUR CO-OPERATION IN COMPLETING THIS QUESTIONNAIRE.

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297

Questionnaire for German Enterprises in the Republic of South Africa

When did your company start operating in South Africa?

01

Does your company operate as a different type in the host country in comparison to its home country? yes, 02 no 03

3. How many employees do you employ: in South Africa 01 in Germany 02 in the world ?03 4. How many business branches to you hold in: in South Africa 01 in Germany 02 in the world ?03 5. In which sector of tions possible!) Primary industry Secondary industry Tertiary industry

the economy does your company operate? (More than one op01 02 03

More precisely: Machinery and supplying industry Clothes and textile Electronics Chemistry Paper industry Construction Banking Refining Public transportation

01 02 03 04 05 06 07 08 09

Consumer goods industry 10 Shipping 11 12 Tourism 13 Food and nutrition Office supply 14 Insurances 15 16 Information technology 17 Consulting business

6. To how many /which countries do you export directly from S.A.? (Number) West Europe 1 Asia 3 North America 5 Australia 7 South America 2 Arab 4 East Europe 6 Africa 8 None 9

01

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7. From which countries do S.A. affiliate import on a regular basis? West Europe 1 Asia 2 North America 3 Australia 4 South America 5 Arab 6 East Europe 7 Africa 8 None 9

8. Which corporate comparative advantages is offered by being in South Africa? 1 Management Relative inexpensive labour force Marketing 2 Political stability Research and Development Tax advantages 3 Access to financial means 4 Location advantages Technology Sound education level 5 High labour motivation Protection of intangible goods 6

7 8 9 10 11 12

9. Which institutions gave assistance by entering the host market? German-South African Chamber of Commerce 01 German Development Society (DEG) 02 German embassy 03 a consulting company 04 the parent company's personnel 05 Miscellaneous 06

10. In which activities do you engage the most? Licensing (1) Export (2) Foreign Direct Investments (3)

11. How would you specify your Investments? Portfolio-Investment (1) FDIs to secure location Re-Investments (2) Investments for expansion

(2) (3)

12. How would you classify your investments in the host country? operative 01 tactical 02 strategic 03 13. In which timeframe do you plan to engage in your next investments? in 2000 (1) in 2001 (2) in 5 years (3) in 10 years (4) 14. How does privatization influence your decision for investments in South Africa? Increase of investments 01 No influence 02 Decrease in investments 03

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15. How will your company finance your planned investments? from the corporation (internal sources) through debt financing in South Africa through equity and credit financing from Germany through government subsidies through other financial means Total investment

299

% % % % _% 100%

16. Which of the following variables in the host country have a crucial importance (Imp) to you? High Imp Low Imp No Imp Qualification of work force Wage rate and power of unions Unrest in the country Political climate Spare federal investment incentives of host country Spare federal investment incentives of home country Low and insufficient infrastructure Foreign culture and value system Foreign currencies and expatriation restrictions Other reasons:

17. Which growth potential do you foresee for the next 5 years in South Africa? high potential 01 medium potential 02 low potential 03 18. How do you evaluate the current economic situation of your company in South Africa? excellent 01 stable 02 constant 03 risky 04 19. How do you evaluate the federal assistance of FDIs from Germany in comparison to the financial assistance in the host country and other industrial nations? excellent 01 sound 02 satisfactory 03 limited 04 20. In which of the following activities is your company involved? Licensing 01 irregular export 03 Export via distributor 05 Export 02 local production 04 product differentiation 06 Foreign direct investment 07

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21. Which of the following strategy describes your current corporate company strategy? cost minimisation 05 generate price advantages 01 02 enhancing marketing 06 price increase company expansion 03 07 introduction of new products 04 increase in import 08 increase in export 22. How do you evaluate the competition with other Multinational Enterprises in South Africa? very intense (1) high (2) medium (3) low (4) weak (5) 23. Is your company listed on the stock market in Johannesburg (JSE)? yes, since (1) no (2) expected in

(3)

24. In which sectors do you see further potential for economic growth in South Africa? Airports Telecommunication Public transportation Tourism Computer industry Pharmaceutical industry Health care Security services Machinery and equipment Banking Insurances Electronic industry Mining Manufacturing others 25. In which form is your company linked with the location of South Africa? Licensing to companies in South Africa Co-production with companies in South Africa (Joint Ventures) other forms of co-operations without capital investment Acquisition of stocks from South African companies Establishment of own production plants in South Africa other economic involvements:

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South African (SA)-European Union(EU) Free Trade Agreement 1.

Do you know the content of the SA-EU Free trade agreement? yes (1) only partial (2) no (3)

2.

Which co-operation agreement between the EU and South Africa do you figure to be the most important? Development co-operation (1) Trade co-operation (2) Economic co-operation (3)

3.

How much increase in turnover do you expect due to the EU-SA FTA? >50 01 >25% 02 10% 03 >5% 04 >1% 05 <0% 06

4.

How important do you consider the SA-EU FTA for your company? very important important less important not important

5.

Which advantages and disadvantages do you see for your company due to the FTA? Advantages: Disadvantages:.

6.

Will you take the impacts of the FTA into account for your strategic planning decision? yes only partial no

7.

How do you value the current import and export restrictions between South Africa and the European Union? trade restrictive trade neutral trade supporting

8.

Will the SA-EU FTA generate an increasing trade with Europe and will this have a positive impact on South African's economic development? positive development neutral development stagnation

9.

Is the SA-EU FTA going to attract further FDI in future, and if so, in what timeframe do you expect a FDI increase to set in? yes: in 5 years in 10 years after the end of concessions no

10. Is the SA-EU FTA going to increase employment in South Africa? yes perhaps no don't know

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11. Which of the following trade agreements do you value most important regarding to the development of South Africa? ACP SACU SADC SA-EU 12. Which sector of the economy do you believe will profit the most from the SA-EU FTA? Machinery and supplying industry Tourism Clothing and textile Consumer goods Electronics Trade and shipping sector Chemical industry Automobile industry Paper industry Food and nutrition Construction Office supply Banking Insureances Refining Information technology Others 13. The EU will provide large investments for development projects for South Africa. Where do you see the most need for financial investments? Infrastructure Tourism promoting Education and training Information technology Crime reducing activities Housing Public utilities Re-education programmes Small Business support Provide venture capital 14. Do you think the SA-EU FTA is a win-win situation for both countries? yes maybe no 15. Which countries will seek South Africa for FDI as an access to the EU market? Asia 2 North America 3 West Europe 1 Australia 4 South America 5 Arab 6 East Europe 7 Africa 8 None 9 16. Which industry do you expect to benefit the most from the EU-SA Free Trade Agreement? Airport Telecommunication Public transportation Tourism Computer industry Pharmaceutical industry Machinery and equipment Health care Security services Banking Insurance Electronic industry Manufacturing Agriculture Mining others 17. How will the trade patterns with the SADC members change due to the SA-EU FTA? big impact medium impact low impact no impact 18. Will the enlargement of the EU (eastern countries) will be of benefit for South African economy? yes maybe no

B ABOUT THE CONTRIBUTORS

Prof. Dr. Bernard Michael Gilroy is Professor of International Economics and Macroeconomics and Coordinator of the International Business Studies Program at the University of Paderborn in Germany. An American by birth, he has worked in Germany and Switzerland since 1979. He first studied (19741978) at Upsala College, USA majoring in Multinational Corporate Studies and German Translation where he obtained his Bachelor of Arts Degree. 1979 to 1983 he then studied Economics at the University of Constance, Germany where he received his Economics Degree Diplomvolkswirt. During 1987-1989 he did his PhD work at the University of St. Gallen, Switzerland. He was a Visiting Scholar at the University of Reading, England during 1991-1992. As an economics lecturer in St. Gallen he also finished his Habilitation research and became an Assistant Professor in 1995. Since October 1996 he has a Full Professorship at the University of Paderborn, Germany. His main areas of research concern the economics of international trade and policy, macroeconomics, monetary theory, the economics of multinational enterprises, integration theory and policy, and network economics. Prof. Dr. Thomas Gries is Professor of International Growth and Business Cycle Theory at the University of Paderborn in Germany. He graduated from the Georg-August-University, Gottingen in 1984. In 1987 he obtained a MA in economics from the University of California and in 1988 a Dr. sc. pol. from the Christian-Albrechts-University, Kiel, 1993 he finished his Habilitation at the Georg-August-University, Gottingen. Since 1994 he has a Full Professorship at the University of Paderborn. In 1999 he was awarded the prestigious Otto-Beisheim-Award by the University of Dresden. The main field of research is international growth and development, international trade and international macroeconomics. Prof. Dr. Willem Naude is Director of Workwell: Research Unit for People, Performance and Policy, at North-West University in South Africa. His field of specialization is the economic development of Africa. He studied at

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B ABOUT THE CONTRIBUTORS

the University of Warwick (UK) where he obtained his M.Sc in quantitative development economics in 1991 and at North-West University where he obtained his PhD in economics in 1993. Prom 1994 to 1996 he was a lecturer at the University of Oxford and Research Officer at the Centre for the Study of African Economies, Oxford. He also taught at the International Development Centre, Queen Elizabeth House, was Visiting Professor at the University of Addis Ababa, Ethiopia and consulted for the United Nations Development Programme. Since 2000 he serves as an elected Councillor on the Southern District Municipality in South Africa. He is a Board Member of Invest North West, the official Investment Promotion Agency (IPA) of the North West Provincial Government of South Africa. Prof. Dr. Karl-Heinz Schmidt is Professor of Public Economics and Social Politics at the University of Paderborn. In 1966 he obtained a Dr. rer. pol. at the University of Gottingen. 1967/68 he was at the University of California/Berkeley. He finished his Habilitation at the University of Gottingen in 1976. Since 1976 he has been Professor at the University of Paderborn. His teaching and research experience include several visits in Nagoya (1983/85), Osaka (1995), Oita (1999), Japan. Starting in 1987 he extended his international contacts to the North-West University, South Africa. His main areas of research and teaching concern microeconomics, economic and social policy, public finance, and history of economic thought. Mr. Norbert Bauer is a graduate student of International Business Studies with his majors in International Business and Information Management at the University of Paderborn in Germany. During his studies he acquired a Diploma from the University of Ulster, Magee College in Londonderry, Northern Ireland. Dr. Stefan Jungblut is Senior Lecturer of Economics at the University of Paderborn. He received his ecomomics degree Diplom-Volkswirt from the Georg-August University, Gottingen in 1994. In 1998 he obtained a Dr. rer. pol. from the University of Paderborn. His research about structural unemployment and growth was awarded the prize for the best PhD thesis by the Universitatsgesellschaft Paderborn (University Society Paderborn). From 1999-2000 he was a Visiting Scholar at the University of California, Los Angeles. His main areas of research include structural unemployment and growth, monetary theory, financial markets and the macroeconomy. Mr. Waldo Krugell is lecturer in economics at the School of Economics, Risk-Management and International Trade at North-West University. He has been a Commonwealth Scholar at the University of Warwick (UK) when he contributed towards this publication. Previously he lectured at the University of South Africa.

B ABOUT THE CONTRIBUTORS

305

Prof. Jonathan Calof is an Associate Professor of International Business at the University of Ottawa and a Director of the Canadian Institute of Competitive Intelligence, he has given over 400 speeches, seminars and keynote addresses around the world on competitive intelligence and has helped several companies and government agencies enhance their CI capabilities. Dr. Calof's research also focuses on international competitive intelligence. His research has been published in numerous academic and management journals including the Competitive Intelligence Review, Journal of International Business Studies, Business Quarterly, International Journal of Small Business Management & International Business Review. As well, Dr. Calof has been given awards and honours from several academic associations, including the Academy of Business Administration, the International Council for Small Business - South Africa, the Administrative Sciences Association of Canada, the Academy of International Business and the Society of Competitive Intelligence Professionals. Prof. Wilma Viviers is professor of international trade at the School of Economics, Risk Management and International Trade at North-West University. Her fields of specialization are the internationalisation of South African firms as well as the role Competitive Intelligence (CI) can play in the enhancing the competitiveness of firms. She holds a PhD in International Economics, a B Ed and a certificate in Export Practice. Prof. Viviers serves on the steering committee of SCIPSA - the Society of Competitive Intelligence Professionals - South Africa.