Rationalization of government structures concerned with

Rationalization of government structures concerned with
University of Pretoria etd – Moeti, K B (2005)
Rationalization of government structures concerned with
foreign direct investment policy in South Africa
University of Pretoria etd – Moeti, K B (2005)
University of Pretoria etd – Moeti, K B (2005)
I would like to acknowledge the following persons:
My promoter, Prof. Petrus A. Brynard for his excellent advice and guidance,
as well as for his much valued friendship.
My co-promoter Prof. Sibusiso Vil-Nkomo for cultivating my interest in
pursuing my doctoral studies with the University of Pretoria, as well as for the
support provided with my thesis.
My HOD, Professor Jerry O. Kuye for his patience and understanding and for
all his assistance in ensuring that I had every possible resource needed to
complete my thesis.
Refilwe, my sister and Lebone, my brother for always being there for me.
I would also like to express sincere appreciation and thankfulness for the
assistance provided by the following institutions:
The Mellon Foundation for believing in the merits of my proposed thesis, and
for the financial assistance provided in support of the study’s research related
Joint Universities Public Management Educational Trust (JUPMET) for
sponsoring my study related activities at the Institute for Social Studies (ISS)
in the Netherlands, as well as for the financial support provided to me in my
capacity as a JUPMET intern lecturer.
University of Pretoria etd – Moeti, K B (2005)
Rationalization of government structures concerned with foreign direct
investment policy in South Africa
This thesis sought to focus attention on the fact that currently in the Republic of
South Africa (RSA) there is no specific governmental body that is charged with
complete responsibility for policy-making and regulation of foreign direct
investment (FDI) in general and multinational enterprise (MNE) investment in
particular. This issue was identified for study as it was noted that firstly, several
other countries (irrespective of their level of development) have such an
organization in place. Secondly and more importantly, it was also noted that
there have been several cases in which a multinational enterprise posed legal,
social and political challenges for host country governments for which such
governments were not empowered to resolve in either the a priori or ex-post
facto sense. This inability on the part of governments to deal effectively with the
challenges created by the unique characteristics and behaviors of multinational
enterprises could possibly have been mitigated through the existence of a
governmental unit tasked with MNE regulation.
The objective of the thesis, was to study the feasibility of designing, developing,
and/or proposing, for South Africa, a governmental unit for policy making, policy
University of Pretoria etd – Moeti, K B (2005)
implementation and control of the inward foreign direct investments of
multinational enterprises, where it could firstly be shown that such an
administrative unit is indeed needed. The arguments made in the study were
framed in the form of a null hypothesis and a single research question. The null
hypothesis of the study being: Ho = there is a necessity to formalize a
government administrative structure for policy setting and implementation of
multinational enterprise regulations in South Africa.
The hypothesis was
examined in terms of being accepted or rejected based in part upon first
resolving the research question of the study which is:
Is there a need for
foreign direct investment policies that apply exclusively to multinational
enterprises? As the thesis was of a qualitative rather than quantitative nature,
the methodological approach primarily examined theoretical, empirical and
anecdotal evidence to ascertain whether the hypothesis should be supported or
rejected. Given that the null hypothesis was not disproved and the research
question was answered in the affirmative, the thesis concluded and
recommended the establishment of a small specialized unit of experts to serve
as part of the public service but independent of any other governmental
department or unit. The proposed unit should work to provide support to other
government agencies in the areas of research, advice and coordination
services. As the environment within which such an organizational unit operates
can be expected to be relatively stable over time, and the work of the unit highly
specialized, it is envisioned that decision making in the unit will be more
centralized than de-centralized.
The thesis ended by exploring optional
organizational designs with the aim of recommending the appropriate
hierarchical arrangements to be established for the proposed organizational
unit. More specific answers with respect to, for example, the number of people
to be employed, their job descriptions, and the remuneration scales to be
applied to their positions are recommended by the thesis for further study.
University of Pretoria etd – Moeti, K B (2005)
Chapter 1 - Introduction
1.1 Introduction
1.2 Point of departure
1.3 Problem statement
1.4 Significance of the study
1.5 The hypothesis and research question
1.6 The objectives
1.7 Methodology
1.7.1 Research methods and research approach
1.7.2 Target population
1.7.3 Perceived constraints
1.8 Scope
1.9 Sequence of the presentation
1.10 Key concepts and terms
University of Pretoria etd – Moeti, K B (2005)
Chapter 2 - A Survey of the Theory of Multinational Enterprises
2.1 Introduction
2.2 Perfect Market Assumption Theories
2.2.1 Differential rates of return
2.2.2 Portfolio diversification
2.2.3 Currency differential
2.3 Imperfect Market Theories
2.3.1 Ownership specific advantages
2.3.1(a) Market power approach
2.3.1(b) Oligopolistic explanation for foreign direct investment
2.3.1(c) The product life-cycle theory
2.3.1(d) Some empirical evidence on
ownership-specific advantages
2.3.2 Location-specific advantages
2.3.3 Internalization advantages
2.4 The Eclectic Paradigm
2.5 The Economic Effects of Foreign Direct Investment
on the Host Country
2.5.1 Economic effects of foreign direct investment
of multinational enterprises associated
with development
2.5.1(a) Foreign direct investment and output growth
2.5.1(b) Direction of causation between foreign direct
investment and economic growth
2.5.1(b)(i) Granger-causality technique
2.5.1(b)(ii) Investment development path
2.5.2 Economic effects of foreign direct investment
associated with employment
University of Pretoria etd – Moeti, K B (2005)
2.5.2(a) Choice of technology and employment
2.5.2(b) Exports and employment
2.5.3 Foreign direct investment and economic development
in the South African context
Economic effects of multinational enterprises’
foreign direct investment associated with
competitive markets
2.5.4(a) Foreign direct investment of multinational
enterprises and industry structure
2.5.4(b) The technology of multinational enterprises
and industry structure
2.5.4(c) Form of multinational enterprise market entry and
industry structure
2.5.5 Policy implications of regulating multinational
enterprises to ensure competitive markets
2.5.5(a) Anti-trust regulation
2.5.5(b) Regulating technology transfer
2.5.6 Balance of payments effects of foreign
direct investment
University of Pretoria etd – Moeti, K B (2005)
Chapter 3 - Historical Perspective of South Africa'
s Investment Climate
3.1 Introduction
3.2 Agricultural, Mining and Manufacturing Investment
and development
3.2.1 Agricultural Investment and Development
73 Indigenous agriculture
73 European settlement and agriculture
74 Modern agricultural Policy
76 (i) Apartheid-era policy and development
76 (ii) Post-Apartheid agricultural policy and development
79 (ii)(a) Marketing
80 (ii)(b) Credit and assistance
3.2.2 Mining Investment and Development
3.2.2 (i) The importance of mining - Strategic Minerals
3.2.2 (ii) The importance of mining - Beneficiation
84 Indigenous Mining
85 Apartheid-era mining industry development
87 Modern mining - Economy and Policy
90 (i) Role of mining in the national economy
90 (ii)(a) Modern mining policy - Privatization
91 (ii)(b) Modern mining policy - Mining Rights
3.2.3 Manufacturing Investment and Development
95 Outward-oriented industrial policy
99 Disinvestment, trade sanctions and the economy
3.3 Conclusion
University of Pretoria etd – Moeti, K B (2005)
Chapter 4 - Global Foundations for Establishing a Need for the Regulation of
Multinational Enterprises
4.1 Introduction
4.2 International Perspective on the Justification
for MNE regulation
4.2.1 Stages of evolvement of multinational enterprises
4.2.1(a) The stages of transition from feudalism to capitalism
4.2.1(b) The stages of competitive capitalism
4.2.1(c) The stages of imperialism
4.2.1(d) Transitional capitalism
4.2.2 Post-war foreign direct investment policy
4.2.2(a) Europe
4.2.2(b) Japan
4.2.2(c) The United States of America
4.2.2(d) Africa
4.3 Contemporary thinking on the regulation
of Multinational Enterprises
4.3.1 Six factors that influence foreign direct investment policy
4.3.1(a) Growth and proliferation of multinational enterprises
4.3.1(a)(i) Significance of the Industrial Revolution
4.3.1(a)(ii) Multinational enterprises in search of raw materials
4.3.1(a)(iii) Overcoming tariff barriers
4.3.1(b) Social effects associated with inward foreign direct
4.3.1(c) National Sovereignty
4.3.1(c)(i) Central and Latin America
University of Pretoria etd – Moeti, K B (2005)
4.3.1(c)(ii) Middle East and Islamic States
4.3.1.(c)(iii) The Former Soviet Union and Eastern Europe
4.3.1(d) Multinational enterprises, corporate responsibility
and international law
4.4 Conclusion
University of Pretoria etd – Moeti, K B (2005)
Chapter 5- Critical Survey of Existing Policies on Foreign Direct Investment in
South Africa
5.1 Introduction
5.2 Public policy defined
5.3 Public policy and change
5.3.1 Policy Innovation
5.3.2 Policy succession
5.3.3 Policy maintenance
5.3.4 Policy termination
5.4 Public Policy Determinants
5.4.1 Public policy role players
5.4.2 Public policy formulation
5.4.3 Rationalization within the public policy process
5.5 Review of FDI/MNE policies - South Africa
5.5.1 Department of Trade and Industry
5.5.1(a) Manufacturing industry
5.5.1(b) External trade and investment relations
5.5.1(c) Company Register Office
5.5.1(d) Department of Trade and Industry - Directorate:
Technology Promotion
5.5.2 Competition Commission
5.5.3 South African Reserve Bank (SARB)
5.5.4 Department of Minerals and Energy
5.5.5 Department of Environmental Affairs and Tourism
5.6 Alternative policy options reviewed
5.6.1 Screening laws
University of Pretoria etd – Moeti, K B (2005)
5.6.2 Indigenization laws
5.7 Conclusion
University of Pretoria etd – Moeti, K B (2005)
Chapter 6- Rationalization of Foreign Direct Investment Policy Structures in the
South African Government
6.1 Introduction
6.2 Defining rationalization, organization and organization theory
6.2.1 Defining rationalization
6.2.2 Defining organization and organization theory
6.3 Evolvement of organization theory
6.3.1 Classical organization theory
6.3.1(a) The bureaucratic approach
6.3.1(b) Scientific management
6.3.1(c) General Management Theory/Administrative Theories
6.3.2 Neo-classical organization theory
6.3.3 Contemporary Organization Theory
6.3.4 Optimum hierarchical structure recommended
6.4 Measurement of Organizational Performance and Structure
6.4.1 Public versus private sector program and project evaluation 192
6.4.2 Complexities of public sector evaluation
6.4.3 Methods of evaluation
6.4.4 Benefits and costs to include in cost-benefit analysis
6.4.4(a) Allocative expenditure programs
6.4.4(b) Distributive expenditure programs
6.4.4(c) Human investment programs
6.4.4(d) Regulatory programs
6.4.5 Time value considerations in cost-benefit analysis
6.4.6 Appropriate discount rate
6.4.6(a) Gross before-tax rate of interest on private investment
University of Pretoria etd – Moeti, K B (2005)
6.4.6(b) Weighted average rate of return
6.4.6(c) Social discount rate
6.4.7 Cost-benefit adjustments
6.4.7(a) Cost effectiveness
6.4.7(b) Monetarizing costs and benefit
6.4.8 Efficiency considerations in cost-benefit analysis
6.4.8(a) Pareto efficiency principle
6.4.8(b) Kaldor-Hicks efficiency principle
6.4.9 Evaluation methods in the South African public service
6.4.10 Summary - Measurement of performance and structure
6.5 Regulation and Structure
6.5.1 Developing a regulatory framework for the regulation
of multinational enterprises
6.5.1(a) Neo-classical market analysis
6.5.1(b) The orthodox post-war economic perspective
6.5.1(c) The Marxist perspective
6.5.1(d) The Nationalist perspective
6.5.1(e) The Environmental perspective
6.5.1(f) Global consumerism
6.5.2 Normative jurisdictional levels of regulation
6.5.2(a) National level of regulation
6.5.2(b) Regional level of regulation
6.5.2(c) International level of regulation
6.6 Conclusion
University of Pretoria etd – Moeti, K B (2005)
Chapter 7- Summary, Conclusions and Recommendations
7.1 Introduction
7.2 Summary of conclusions of each chapter
7.2.1 Chapter 1 – Introduction
7.2.2 Chapter 2 – A Survey of the Theory of
Multinational Enterprises
7.2.3 Chapter 3 – Historical Perspective of South Africa’s
Investment Climate
7.2.4 Chapter 4 – Global Foundations for Establishing
a Need for the Regulation of Multinational
7.2.5 Chapter 5 – Critical Review and Analysis of Existing
Policies on Foreign Direct Investment in
South Africa
7.2.6 Chapter 6 – Rationalization of Foreign Direct
Investment Policy Structures in the South
African Government
7.3 Recommendations
7.4 Issues For Further Study
7.5 Conclusion
University of Pretoria etd – Moeti, K B (2005)
2.1 The pattern of the investment development path
6.1 Maslow`s Hierarchy of Needs
6.2 A simple open system
6.3 Consumer surplus
6.4 Demand curve and consumer surplus
6.5 Net social benefit of consumers and producers
6.6 Cost-benefit analysis to include government
6.7 Basic-needs approach to include government
University of Pretoria etd – Moeti, K B (2005)
3.1 Major Trade Sanctions against South Africa , 1986
3.2 South Africa`s Major Exports and Imports in 1986
(US$ in millions)
3.3 Flows of Sanctioned South African Exports
5.1 Summary of FDI related policies as per responsible institution 162
5.2 Liberal versus conservative policy options
University of Pretoria etd – Moeti, K B (2005)
…Free markets embody no mechanism that is responsive to all the needs of
the planet.
Informed regulation is therefore essential to ensure sustainable
Cleaver, Tony – Understanding the World Economy: Global
issues shaping the future, 1997 p.23
Public policy analysis is an important public management sub-discipline that
provides the necessary tools for improving the levels of efficiency with which
public institutions operate.
In general terms, the analytical construct of the
current thesis is grounded in public policy analysis and is based on gauging the
effectiveness with which the South African government can deliver on it’s
regulatory responsibilities whilst simultaneously giving priority to sustainable
development objectives. More specifically, government must balance the need
to regulate foreign direct investment with the need to attract much needed
investment capital into the country.
University of Pretoria etd – Moeti, K B (2005)
Globalization refers to the trend-wise growth in the level of integration of
economies and societies around the world (World Bank 2002:23). With the
contemporary phenomenon of globalization taking it’s course, issues of poverty
and development have found new perspectives from which analysis and the
generation of workable resolutions are being created. Generally, globalization
has been observed to have benefited some developing countries with rapid
growth and prosperity, whilst simultaneously increasing inequality and
environmental degradation in the poorest of countries. According to the World
Bank (2002:85) the key to harnessing the benefits offered by globalization have
less to do with open trade and investment policies but more to do with effective
domestic policies and institutions in these and other areas (Cf. Paul and Garred
December 2000:3-4). A very specific form in which globalization is taking place
is through the foreign direct investment of multinational enterprises. Both, the
benefits and the negative externalities associated with this type of investment in
host countries is the general focus area of the current thesis.
Although big business (especially in the form of multinational enterprises) has
much to contribute towards global economic advancement, a substantial
proportion of the organizations that are in a position to operate monopolistically
or as oligopolists also tend to operate internationally as multinational
enterprises. This circumstance leads to a number of concerns with regards to
regulating multinational enterprises least of which are the concern for the
competitive effects on local economies as well as concerns over economic and
political sovereignty.
Further, due to the fact that multinational enterprises are incorporated under the
laws of one country whilst having the flexibility to establish subsidiary or branch
operations in other countries, it will not always be possible to regulate, to the full
University of Pretoria etd – Moeti, K B (2005)
extent of the law, those multinational foreign businesses that choose to leave
the jurisdictional boundaries of the host country.
A social problem exists or can be defined as done by Hoogerwerf (in Wittrock
and Baehr (eds.) 1981:31) who states that “a [social] problem exists if there is a
discrepancy between a goal or some criterion and the perception of an existing
or expected situation.”
In the case of multinational enterprise regulation
therefore, in defining a problem, or assessing, or justifying policy it is necessary
to start with a clear indication of the goals or expected benefits, if any, that the
government intends to derive from its relationship with foreign multinational
Further, as Dunning (1993:566) has stated, “the success of
government policy towards … inward direct investment depends upon the
effectiveness of the administrative machinery set up to implement and monitor
the policies decided upon.” It follows then that it is not enough to espouse a
general approach to foreign direct investment; but rather it is necessary to
articulate the government’s policy formally and clearly within well defined
organizational structures.
Point of Departure
The current study topic was motivated by the fact that other studies had
neglected to address the issue of government policy concerning foreign direct
investment and or multinational enterprise investment in South Africa.
preliminary database search (conducted in May 1999) of all registered research
with the Human Sciences Research Council (HSRC) for all South African
Universities showed that the topic of multinational enterprises in South Africa
had scarcely been studied.
By that date (May 1999) there were two other
dissertations on multinational enterprises in South Africa. C.O. Howard1993
University of Pretoria etd – Moeti, K B (2005)
(M.A. UCT) examines the Challenges of business and political risk faced by
multinational enterprises considering investing in South Africa.
R.V. Cohen
1979 (M.B.A. UCT) is also concerned with factors that influence the decisions of
foreigners to invest in South Africa, and analyzes these factors to come up with
methods of encouraging foreign investment into the country. Cohen’s focus is
on business management and making recommendations to South African
entrepreneurs to engage multinational enterprises in licensing agreements and
joint ventures.
The point of departure of the current study is to address and study the role of
Government in controlling the entry and overseeing the activities of
multinational enterprises in South Africa.
Problem Statement
Currently in the Republic of South Africa (RSA) there is no specific
governmental body at any level of government that is charged with complete
responsibility for policy-making and regulation of foreign direct investment in
general and multinational enterprise investments in particular.
As a result,
foreign investment into the country is characterized by a lack of substantive
policy, and what policy does exist in the current dispensation is highly
fragmented across several departments, directorates and sub-directorates thus
leading to high levels of inconsistent policy and low levels of coordination in the
administration of such investments and projects. Thus, in light of the perceived
effects of foreign direct investment upon the host country and given the size
and scope of multinational enterprise business activity in South Africa, closer
examination of government policy and administration applicable to these
businesses is warranted.
University of Pretoria etd – Moeti, K B (2005)
Significance of the Study
The relevance of this study relates to the recognition of the importance of
foreign capital investments to the local economy. In brief, the macro-economic
implications associated with multinational enterprise investments are:
1. Employment creation;
2. Balance of payments effects;
3. Technology and skills transfer;
4. Competitive effects in the local economy;
5. Environmental damage and resource depletion.
Regarding employment creation, it may be argued that multinational enterprises
enhance employment levels in the host country by increasing employment.
However, this argument is countered by the possibility of job losses in less
competitive domestic firms.
With regard to the balance of payments
considerations, a host country’s balance may be improved by the inflow of new
capital represented by a direct investment. While on the other hand, this initial
gain may be offset by the long-term outflow of capital through repayment of
loans and through dividend remittances. In the event that these outflows were
to exceed the initial investment, then a net loss to the balance of payments
would result. As to the question of technology and skills transfer, the case is
often made that multinational enterprises can enhance a host economy through
the transfer and dissemination of the advanced technology and managerial
skills that they preeminently posses.
This assertion, however, inflates the
assumption of complete willingness on the part of the multinational enterprise to
share its competitive advantages with local firms and workers as dictated by
government policy.
University of Pretoria etd – Moeti, K B (2005)
In reference to competitive effects, it is often asserted that multinational
enterprises will drive out local competition. However, the counter point is made
that a multinational enterprise may buy many goods, services and supplies
locally and thus may stimulate local entrepreneurship. Finally, environmental
damage and resource depletion are most often seen as externalities associated
with multinational enterprises as well as with misguided or weak regulation.
The problem that makes this subject worthy of study is the apparent lack of
administrative responsibility and control for the entry and activities of
multinational enterprises in the Republic of South Africa (RSA).
The Hypothesis and Research Questions
Ho = There is a necessity to formalize a government administrative structure for
policy setting and implementation of multinational enterprise regulations in
South Africa.
Research Question 1: Is there a need for foreign direct investment policies that
apply exclusively to multinational enterprises?
The Objectives
Given the important role that multinational enterprises play within a domestic
economy, it becomes imperative then to go beyond merely describing their
impact and influence. With this in mind, sequentially, the objectives of this
study are:
to survey the literature on the theory of multinational enterprises as a
backdrop against which an administrative structure for policy-making,
University of Pretoria etd – Moeti, K B (2005)
policy-implementation and control of multinational enterprises in
South Africa may be designed, developed and/or proposed;
To examine the historical perspectives of South Africa’s investment
climate to highlight the crisis brought about by the trade sanctions
and disinvestment campaigns against South Africa during the 1980s;
To examine the global foundations for establishing the regulation of
multinational enterprises by considering the experiences of selected
industrialized and developing countries;
To critically review the existing policy regime on foreign direct
investment in South Africa including the rationalization of foreign
direct investment policy structures thereof; and
To make policy recommendations on the desired government
administrative structure for policy-setting and implementation on
multinational enterprise regulation in South Africa.
The methodological approach employed is essentially brought into existence by
- and an abstraction of - the objectives defined for this study. Thus, although
the subject concerning the economic implications of multinational enterprise
operations in the host country is relevant to any discussion of these forms of
business endeavor, the focus of this study is rather on the examination, design
and development of the appropriate governmental policies and administrative
structures for multinational enterprise regulation in the Republic of South Africa.
The emphasis is on determining how and where policy should be formulated
and implemented, as opposed to determining what the policy should be.
University of Pretoria etd – Moeti, K B (2005)
1.7.1 Research methods and research approach
The principal research method followed is based on surveying the academic
literature on foreign direct investment to establish theoretical and practical
principles and guidelines for resolving the pertinent policy and structural
questions raised thereof. Although this approach is followed throughout the
study, the second chapter – A Survey of the Theory of Multinational Enterprises
– is dedicated toward this end. More specifically, chapter two seeks to identify
the issues of relevance that must be considered prior to formulating, amending
and implementing regulatory policy for foreign direct investment. Generally,
these issues pertain to understanding the motivation for organizations to
become multinational in their operations and the possible positive as well as
negative effects of their activities that may occur within the host country.
The second research approach incorporated in the study is comparative policy
analysis – which serves as a tool to guide policies and policy structures toward
international best practices that may be adaptable to the uniquely South African
Thirdly, empirical research is conducted by way of discovery and
analysis of the currently existing implicit and explicit policy measures and policy
structures in South Africa.
Fourthly, an empirical historical review and analysis of the issues and policies of
foreign direct investment in South Africa is utilized to gain an understanding of
how these have evolved over time as well as providing the contextual setting
within which current policy measures can be holistically perceived. Finally, the
nature of the study calls upon the active engagement and discourse in subjects
spanning various academic disciplines and is focused mainly on the theory of
University of Pretoria etd – Moeti, K B (2005)
public policy processes as well as general administrative sciences and
economic theory.
1.7.2 Target population
The target population under study is the majority foreign owned business
enterprises operating in South Africa. Majority owned meaning that one person,
or a group of persons who share a common interest, hold the controlling share
of ownership (51% or more) in the enterprise.
Perceived constraints
The perceived constraints considered for the study are the following:
A complicating factor in studying today’s multinationals is the fact that
over time many multinational enterprises have combined or shared
resources by way of mergers and acquisitions that categorization of a
multinational enterprise as an organization with a specific home
country of origin gains much complexity. However, the study focus is
on host government policies and structures thus, the nationality of the
multinational enterprises home country is rendered somewhat
Classifying domestic firms that are in partnership with foreign interests
as multinational foreign investors is also problematic. This situation
can be addressed by focusing on the majority ownership of the
business in question. Thus the study will define as foreign investors
those businesses that are majority (51percent or more) foreign-owned.
University of Pretoria etd – Moeti, K B (2005)
Defining a multinational enterprise is complicated by the fact that there are
varying degrees of involvement of foreign businesses into a host country’s
economy. As stated by Robock and Simmonds (1989:7) “the dividing line to
mark the stage at which a company becomes multinational is difficult to
Thus it can be ascertained that cross border involvement of
business enterprises runs the gamut from the low end of exporting, to
intermediately establishing warehouses and marketing operations abroad and
at the high end of the spectrum opening up manufacturing operations abroad.
In limiting the scope of the study to manageable proportions, the multinational
enterprises dealt with here are those at the high end of the spectrum. That is
those enterprises that maintain manufacturing and/or service operations within
a host economy/country - such that the country in which the enterprise is
incorporated is the home country and the overseas states where production,
service provision, employment and sales takes place are the host countries.
The geographic coverage of the study topic is limited to the sovereign
boundaries of the Republic of South Africa.
Further the focus is on South
African policy where South Africa is the host country of foreign direct
No significant attempt at coverage of South African policy in
regulating it'
s own (or home) multinationals is undertaken.
The host country'
s political, social and economic environments within which the
multinational enterprise operates set the frame of reference from which
regulation and policies evolve. Further, the policy process does not take place
instantaneously, but rather occurs incrementally. Thus, although the study'
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temporal focus is on present and proposed future policy initiatives, historical
events are discussed as they are philosophically influential to the current states
of affairs and additionally serve to define future states as either possible or
Hierarchically, the study would gain marginally by leaving itself open to policy
issues at all three spheres of government.
However, the main focus is on
national policy and national legislation as these are much more readily
accessible than is the case at the sub-national levels of government.
Sequence of the presentation
Chapter 1, the Introduction of the dissertation identifies the problem to be
addressed in the statement of the problem, proposes hypotheses and research
questions to be explored in order to resolve the problem, identifies the
methodological approach to be used and sets limitations on the scope of the
study. Chapter 2 reviews the literature that is relevant to the study topic with
the anticipation that later chapters will be made easier to contextualize as a
result thereof.
In chapter 2 examination is made of early as well as
contemporary academic literature that informs policy on the regulation of
multinational enterprises (MNEs). Much of the seminal literature was motivated
by concerns over the market power that these corporations tend to possess.
Chapter 3 is entitled - Historical Perspective of South Africa’s Investment
This chapter aims to provide background and insight into the
environments (political, economic and social) within which multinational
enterprises operated in South Africa and examines how changes in these
environments over time may have impacted on foreign investment decisions on
University of Pretoria etd – Moeti, K B (2005)
the part of multinational enterprises as well their impact on the evolvement of
government policy in this area. Chapter 4, Global Foundations for Establishing
a Need for the regulation of MNEs, critically examines a number of issues put
forward in the literature that argue for a regulatory agenda for foreign investors.
These issues are examined in the South African context. In chapter 5, entitled
Critical Survey of Existing Policies on Foreign Direct Investment in South Africa,
the evaluation of current policies and administrative structures relevant to the
regulation of the foreign direct investment of multinational enterprises is
conducted. The focus is on scanning, surveying and evaluating any existing, or
emerging policies within the South African public sector that impacts on the
activities of foreign multinational investors. This survey sets the bases upon
which the next chapter (chapter 6) is founded to the extent that proposed
changes in structure, or alternatively rationalization, can only be undertaken
once the exact nature of the structures and the policies to be dealt with by those
structures are made clear.
Chapter 6, Rationalization of Foreign Direct Investment Policy Structures in the
South African Government, seeks to assess the scope for rationalization of
those government structures identified in the previous chapter in terms of the
normative principles of organization theory and cost-benefit analysis. In this
regard, perceived shortcomings in the current administrative structural
arrangements are identified in order that a more effective and efficient
arrangement can be recommended in the final chapter, Chapter 7. Chapter 7,
entitled Conclusion and Recommendations, highlights the most pertinent issues
for consideration in attempting a restructuring exercise of foreign direct
investment policy structures. Chapter 7 also formulates general conclusions
and recommendations, and proposes issues for further study.
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Key concepts and terms
Multinational Enterprise - MNE
Of the many varied uses of the term multinational enterprises (MNEs), the term
is used here to refer to enterprises that own (in whole or in part), control and
manage production or service facilities outside the country in which they are
Further, An MNE is classified here as a form of Foreign Direct
Investment (FDI); FDI, however, is not limited to multinational enterprise
investments, and also includes direct equity investment which normally results
in little or no managerial control. Therefore, the term FDI can be (and is) used
somewhat interchangeably with the term MNE as the latter is a subset of the
Foreign Direct Investment - FDI
The usage of the term foreign direct investment in the context of the study shall
refer to investments into a country made by foreign interests. These are capital
investments (in terms of size and duration of commitment) and can occur as
either physical or equity investments.
Physical capital investments are
investments in plant and equipment, as in the establishment or support of a
management control by the investors or parent company. In contrast, equity
capital investments are investments in stock and/or bond ownership and
consequently may or may not represent a controlling interest in the
management of the investment (depending upon the size of the investment).
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Home Country
A precise definition of the term as it will be used in the study is that offered by
Hoogvett and Puxtey (1987) in which they define a home country as " the
country from which a foreign investment originates and where the parent
company of a multinational corporation is domiciled”.
Host Country
The country in which business enterprises with foreign ownership and/or control
are located.
The term monopoly is used to refer to an organization that is the sole producer
or supplier of a given good or service.
This condition guarantees the
organization excessive control over prices and supply of the good or service.
An oligopoly refers to the few large organizations competing in a given market
against each other as well as against a larger number of small companies in
that same market.
This market characteristic tends to lead to monopolistic
market conditions when the above-mentioned large organizations choose to
collude with each other to control prices and supply rather than to engage each
other in possibly destructive competition.
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Under international law a country can normally only exercise it'
s jurisdiction and
sovereignty within it'
s own territorial boundaries. However, exceptions to this
international legal principle are referred to as cases of extraterritoriality and
have been tested in cases of home country governments attempting to exercise
control over business enterprises in another country on the basis that these
enterprises are incorporated in, and contracted to uphold the laws of, the home
This is an unresolved issue as many host countries also require
foreign business enterprises to submit articles of incorporation in order to
register to conduct business in the host country.
Extraterritoriality has also
been tested in cases of host governments attempting to hold foreign parent
companies of subsidiaries liable for the acts of the subsidiary in the host
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A Survey of the Theory of Multinational Enterprises
As a starting point for an academic discourse of public policy and administration
as these may be applied to the subject of foreign direct investments (FDI) by
multinational enterprises (MNEs), two preliminary sets of questions need to be
considered by policy-makers. The first set of questions should seek to address
and understand the general theory on multinational enterprises with regard to
explaining the factors that motivate a firm to choose this type of foreign direct
investment over exporting or licensing, as well as the factors that have led to
the worldwide proliferation of this phenomenon. The second set of questions to
be considered by policy-makers should address the multinational enterprises’
economic and social impact on host and home countries.
Posing and attempting to resolve these two sets of questions has far reaching
implications for host state - foreign investor bargaining relationships in terms of
regulation. Additionally, these questions also have implications for identifying
any possible abuses of the host state by the multinational enterprise that may
occur either outside of or through their negotiating relationship.
In terms of explaining the motivating factors of establishing a multinational
enterprise, there exists quite an extensive array of disparate theories and views
extending from the pioneering works of Stephen Hymer (1960, 1968) and
Raymond Vernon (1966), whose contributions were the market power approach
and the product life cycle theory respectively.
Later theories that gained
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prominence were the oligopolistic follow the leader theory of Knickerbocker
(1973), the internalization of transactions costs theories first proposed by Coase
(1937, 1960), and John Dunning’s (1993) eclectic paradigm. The first section of
this chapter reviews these and other theories aimed at the discernment of this
issue. These theories are separated and dealt with according to whether or not
they assume perfect markets.
The discussion that then follows reviews theories that have been proposed to
explain the economic impact, within the host-state, of foreign direct investment
in the form of the establishment of multinational enterprise subsidiaries.
Perfect Market Assumption Theories
The term perfect capital markets refers to the economic state of affairs of a
market in which prices are set competitively through supply and demand, and in
which there are a sufficient number of producers such that these producers
become “price-takers” rather than “monopolistic or oligopolistic price setters”.
Further, the perfect markets assumption contends that there are no barriers to
either the entry of a market by producers or to international capital flows.
Although multinational enterprises tend to operate mostly under conditions of
imperfect markets, it is still worthwhile to take into consideration those theories
that assume perfect markets. This is because perfect market theories do not
discount the fact that the foreign direct investment of multinational enterprises
normally takes place in imperfect markets, but instead they assume away the
complicating factors of imperfect markets on the belief that the structure of the
market is inconsequential in their proposed analysis.
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Theories based on perfect market assumptions include (but are not limited to) –
the differential rates of return, portfolio diversification, and currency differential.
Each of these concepts will be reviewed in turn.
2.2.1 Differential rates of return
The Differential rates of return theory argues that foreign direct investment flows
are mainly attributable to the differing rates of return on capital that firms can
earn in different countries.
The argument here is that foreign capital and
investment will move out of countries with low relative rates of return on capital
to those with higher rates. The underlying rationale of the Mc-Dugall Kemp
model (Chen 1983: 18-20) of this hypothesis is that rates of return on capital
are inversely related to the availability of capital within a given country such that
countries experiencing capital scarcity will pay higher rates for invested capital
thereby attracting foreign capital from those countries that possess excess
capital. Eventually, investment flows will cease (or at least diminish) as supply
and demand forces act to equalize the rates of return to capital of the two
The differential rates of return theory seemed to be supported by empirical
evidence pertaining to United States foreign direct investment in the late 1950s.
During this period, after-tax rates of return earned by United States subsidiaries
in manufacturing in Europe were consistently above the rate of return earned by
United States domestic manufacturing investments.
However, this same
empirical evidence seemed to contradict the differential rates theory during the
period of the 1960s when United States foreign direct investment in Europe
continued to rise whilst at the same time the rates of return for United States
subsidiaries in Europe were consistently below the rates of return on United
States domestic manufacturing (Lizondo 1991:69). Additionally, the differential
rates of return theory contradicts the available evidence that shows that there is
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a substantial amount of two-way foreign direct investment taking place between
countries. That is, there are numerous cases in which firms from country A
invest in country B at the same time that firms from country B are investing in
country A (Chen 1983:18-20; Cf. Lizondo 1991:69).
Portfolio diversification
Portfolio diversification theory uses the same rationale as that used in the
differential rates theory but adds to that argument a risk factor. It argues that
when a firm is in a
position to choose among various alternative investment
projects, the determining factors in the decision will be both the differential rates
of return and the opportunities to reduce risk through diversification. That is, a
firm could reduce it’s overall risk by undertaking projects in more than one
country since the returns on activities in different countries are likely to be less
than perfectly correlated (Lizondo 1991:69). Although a number of empirical
studies have been conducted to test this theory, none offers strong support
(Hufbauer 1975; Cf. Agarwal 1980).
Currency differential
The currency differential theory asserts that international direct investment flows
(as opposed to portfolio investment flows) will tend to move out of countries with
strong currencies and into countries with weaker currencies. Several differing
models have been proposed to explain this relatively consistent empirical result.
Aliber (1971) for example, proposes that this phenomenon might be a result of
the fact that investors have a bias against firms from weak currency countries.
This bias can be attributed to the fact that weak currencies are perceived to
contain greater risk and volatility than stronger currencies.
Thus, investors
(both in the strong currency country and in the weak currency country) will value
the investment stream from the firm of the strong currency country at a higher
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capitalization rate. In other words, investors are willing to pay a higher price to
invest in the strong currency country firm as compared to the firm from the weak
currency country. If this is the case, then firms from weak currency countries
will not have an incentive to make direct foreign investments into strong
currency countries, while firms from strong currency countries will have an
advantage over indigenous firms in the weak currency country and will thus find
it profitable to undertake foreign direct investment in such countries.
An alternative explanation of the currency differential findings is offered by Froot
and Stein (1989) and is based on information imperfections in the capital
market. Their supposition is that information imperfections may lead to a real
depreciation of the domestic currency in a given country that effectively lowers
the wealth of domestic residents of that country while at the same time
increasing the wealth of foreign residents. As a result of the higher relative
wealth and thus cheaper input costs obtained by foreign investors, they will find
it profitable to invest in the depreciated currency country.
A similar but more complete explanation can be found in Caves (1988). Caves
takes this same argument a step further by adding that it is usually in cases
where a depreciation in currency is expected to be reversed (i.e. currency
appreciation is expected at a later stage) that foreign direct investment is
motivated as firms can buy low and sell high.
Most empirical studies of the currency area hypothesis focused on whether an
over-valuation of a currency is associated with foreign direct investment
outflows and whether an under-valuation is associated with foreign direct
investment inflows.
Studies conducted of foreign direct investment in the
United States, the United Kingdom, Germany, France, and Canada yielded
results that were consistent with the hypothesis (Cf. Agarwal, 1980).
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2.3 Imperfect Market Theories
The application of classical trade theory as an analytical tool for international
trade and investment has important limitations and constraints.
shortcomings relate directly to the simplifying assumptions upon which it'
theoretical framework is based - that is, under perfect market assumptions, only
goods are assumed to be internationally mobile whereas no consideration is
given to the mobility of factors of production. This assumption does not allow
for the possibility or existence of foreign direct investment but instead offers a
framework for analysis of import and export trade only (Chen 1983: 16).
A further limitation of classical theory is it'
s assumption that markets are
perfectly competitive. Given that oligopolistic and monopolistic markets are the
business environments within which multinational enterprises operate and
foreign direct investment takes place, the assumption of perfect markets further
negates the usefulness of classical trade theory as a tool for studying foreign
direct investment and multinational enterprises (Nelson and Silvia in Erdilek
(ed.) 1985:97; Cf. Chen 1983:16; Cf. Muchlinski 1995:7). In fact, according to
Hymer (1976) the major motivating factor for investing abroad is the existence
of imperfect competition at home. Hymer (1976) viewed the extension of the
multinational enterprises foreign operations as a strategic move to eliminate
competition at home and abroad. Alternatively, Hymer(1976) was saying that
control of foreign operations is necessary in order to realize fully the returns on
certain advantages and abilities that the firm possesses.
Hymer (1976)
asserted that these ownership-specific advantages could be maximized through
international horizontal and vertical integrations under oligopolistic market
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Imperfect market theories have focused on ownership specific advantages,
location specific advantages and internalization advantages. Each of these will
be discussed in turn.
Ownership specific advantages
Ownership specific advantages refer to unique characteristics of a particular
firm that provide for a competitive advantage over other firms. Examples of this
include marketing strategy, advanced technology, capital asset endowment,
liquid asset endowment, and human resource capacity. Any of these ownership
specific advantages can lead to, or be used to exploit, market imperfections.
Market imperfections can further be exploited to the financial benefit of the firm
through foreign direct investment.
The approach to explaining ownership specific advantages has been done from
a number of different perspectives. The approach taken in the passages to
follow is to examine imperfect market theories of ownership specific advantages
as explained under the market power approach, oligopolistic reaction theory
and the product life cycle theory.
2.3.1 (a)
Market power approach
The market power approach focuses on the motivation of the firm to increase
it’s market power, in the face of stern oligopolistic competition, through the
exploitation of it’s ownership-specific advantages (Cantwell in Pitelis & Sugden
(eds.) 1991:21). It is argued that in the early stages of growth, the oligopolist
firm will experience steady growth in the domestic market share. However,
domestic market concentration will expand to the limit in an oligopolistic market,
and thereafter it is only possible for oligopolists to maintain or increase their
market shares by expanding their competition to foreign markets.
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The argument is further augmented by two rationalizations as to why the
resultant competition into foreign markets, by oligopolists, takes the form of
foreign direct investment as opposed to exports (Cowling and Sugden 1987).
First, as a way of maximizing foreign profits, the multinational enterprise can
better negotiate wages, than is possible by producing at home and exporting,
by threatening to exercise it'
s capability to relatively easily shift production
between alternative locations. Second, the multinational enterprise can weaken
the bargaining power of trade unions, whose power is magnified by the size of
the firm within which they are organized, or by contracting out work previously
done within the firm to a network of dependent subcontractors, both locally and
2.3.1 (b)
Oligopolistic explanation for foreign direct investment
The oligopolistic reaction theory is based on the market power dictum but
extends the arguments of the market power approach to discuss specific
behaviors of firms in oligopolistic industries and markets.
By definition,
oligopoly theory asserts that rival firms in oligopolistic industries counter each
others moves by making similar moves themselves.
Knickerbocker (1973)
hypothesized that this follow the leader corporate behavior extended to foreign
direct investments as well. Knickerbocker (1973) empirically tested the validity
of the oligopolistic reaction theory in the case of foreign direct investment by
United States (US) multinational enterprises in the post-World War II years of
1948 to 1967. The study was limited in scope to operations of enterprises in
manufacturing industries.
The entry concentration index (ECI) is the quantitative measure used in
Knickerbocker’s study as a measure of the extent to which United States
enterprises, by industry, have bunched together the establishment of their
foreign manufacturing subsidiaries. An entry concentration index measures the
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extent of oligopolistic reaction within a given overseas industry based upon the
notion that within a limited period of time, the number of foreign (in this case –
United States) subsidiaries established there is an indication of the degree of
oligopolistic reaction within that industry. The entry concentration indexes were
developed from data on 23 countries within which approximately 83% of all
foreign manufacturing subsidiaries of United States firms (excluding those in
Canada) were established during 1948-1967.
Additionally, the measure of industry structure used was the industry
concentration ratio (ICR): that part of an industry’s total output that is produced
and sold by the leading four or eight or n firms in an industry and which is
expressed as the n-firm concentration ratio.
If, for instance, the collective
output of the four largest firms in an industry is 80% of total industry output,
then the four-firm concentration ratio for that industry will be 80%.
Knickerbocker (1973) draws these two measures together to test the "follow the
leader"/oligopolistic reaction theory. The hypothesis (Knickerbocker 1973:53) of
the study is that “for US industries involved in international expansion after
World War II, the higher the concentration of output of the leading firms in a
given industry, the higher that industry’s level of oligopolistic reaction”.
Among the conclusions reached by Knickerbocker (1973) were first, that entry
concentration (the bunching together of foreign direct investments) has been
positively associated with industry concentration.
Second, the positive
association observed between the two variables seems to have been the result
of the behavior of a few leading firms in each industry.
And third, entry
concentration has tended to be most intense in industries in which marketing
capabilities, above all else, have been the key to success.
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Knickerbocker’s (1973) statistical results also revealed a nonlinear relationship
between the two key variables (i.e. entry concentration indexes and Industry
concentration ratios) such that oligopolistic reaction behavior holds up to a
point. Beyond this point industry leaders tend to reduce the intensity of their
competition. This finding supports the belief that as the marketing strategies of
oligopolists are highly interdependent, the timing and placement of their foreign
direct investments may be determined by an understanding (implicit or explicit)
among them that excessively intense oligopolistic reaction is contrary to the
best interest of all.
Knickerbocker’s oligopolistic reaction theory, at best, can only be a partial
explanation of foreign direct investment. This theory can explain that oligopolist
firms invest defensively to counter the foreign direct investment of the initiating
firm, but it does not attempt to explain why the initiating firm chose to invest
abroad in the first place (Lizondo 1991:73).
2.3.1 (c)
The product life-cycle theory
The product life cycle theory proposed by Vernon (1966) maintains that the
foreign investment decisions of the firm are significantly influenced by the life
cycle patterns of its main products.
More specifically, the decision by the
multinational enterprise as to where to locate production facilities is determined
by the nature of the firms products vis-à-vis the stage occupied by these
products within the product life cycle. Vernon (1966) defines the product life
cycle as consisting of three stages, namely – firstly, the new product stage,
secondly, the maturing product stage and lastly, the standardized product stage
(Vernon 1966 cited in Chen 1983:26-9). The theory assumes that the firm in
question is an innovation-based oligopolist from a developed country.
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The first stage is the new product stage during which the product is first
introduced in the market. During this stage, production facilities and sales are
both based within the domestic market. This is due to uncertainties as to the
sustainability over time of the product'
s demand in distant markets.
The second stage is the maturing product stage which is characterized by peak
demand for the product in the domestic market and modest but growing
demand for the product in overseas markets. The growth in demand for the
product in the domestic market occurs as consumers become more
knowledgeable about the product while at the same time the products price falls
due to improved efficiency and standardization of production processes.
Overseas demand and sales of the product develop during this stage as the
product meets tough competition in the domestic market. With the eventual
saturation of the local market by the innovating firm and it’s competitors, the
profit levels of the innovating firm are initially maintained through increased
exports. It is during the later phases of this stage that the innovating oligopolist
invests in production facilities abroad, usually in other developed countries
whose income levels and consumer tastes are similar to those of the domestic
The third stage is the standardized product stage during which the product has
lost it’s innovative advantage such that it’s production processes are commonly
known in other developed countries. At some point, the innovative oligopolist
will encounter competitive pressures from developed host country firms who
begin to produce a substitute product and may even export some of this product
to the home country of the foreign oligopolist. In order to continue profiting from
the product, the foreign oligopolist must further reduce costs by investing in
production facilities in developing countries. During the initial phases of this
stage, the products produced by the foreign oligopolist in the developing
countries are usually not for sale in those markets but are instead exported
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back to the home country of the oligopolist or to other developed countries. In
the latter phases of this stage, the oligopolist will attempt to develop a market
for the product in developing countries.
The product life cycle theory is supported by empirical analysis of foreign direct
investment for the post-war period up to the early 1970s. That is, the theory is
consistent with the rise of foreign direct investment by United States firms in
Western European countries before subsequently investing in the developing
countries (Chen 1983:28).
The product life cycle theory has been criticized, however, for being a partial
theory that addresses itself to foreign direct investment of the market seeking
kind only. Other types of foreign direct investment such as resource based and
efficiency seeking modalities are unaccounted for (Dunning 1993:71). Further,
the product life cycle theory has also been criticized for failing to explain the
more contemporary phenomena of foreign direct investment such as the fact
that in many cases a new product is introduced to domestic and foreign
consumers almost simultaneously (Chen 1983:28).
The declining usefulness of the product life cycle theory of foreign direct
investment has been attributed to two factors, namely – the network’s spread of
multinational enterprises, and the shrinking of the income and technology gap
amongst developed nations.
The network’s spread refers to the fact that
modern multinational enterprises tend to invest in a network of subsidiaries
around the world, and this network often shares information and resources such
that new products can be introduced simultaneously in different parts of the
world, or if a product is introduced in country A, the interval of time between the
introduction of the product in country A and its first production in country B has
been rapidly shrinking. Shrinking technology and income differences amongst
developed countries weakens the critical assumption of the product life cycle
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theory that innovative oligopolists are motivated to engage in foreign direct
investment as a result of markedly different economic conditions in foreign
markets (Chen 1983:29; Cf. Cantwell in Pitelis & Sugden (eds.) 1991:37-8).
2.3.1 (d)
Some empirical evidence on ownership-specific advantages
From the spectrum of monopolostic ownership-specific advantages available to
manufacturers, Lall (1980:Chapter 1) selected to examine technology, product
differentiation, capital intensity, scale economies and skills. A sample of 25
industries was extracted from data provided at the two and three digit industry
levels. The statistical technique used is ordinary least squares (OLS) multiple
The study examined monopolistic advantages in terms of their influence on total
foreign involvement (defined as the sum of United States exports and United
States foreign production).
The focus was on determining how these
advantages affected foreign involvement in total as well as in its component
The statistical results indicated that Research and Development (RD), as a
measure of technological intensity, exhibited higher propensities for export than
for foreign production. However, this finding should take into account the fact
that this advantage is most likely to exhibit a ‘cyclical’ effect. That is, as stated
by Lall (1980) “…in the early stages of innovation, there are both countryspecific
marketing units) reasons for keeping production at home. In later stages, as
techniques, skills and products become standardized, foreign demand and
competition arises, it becomes an advantage which is easy and profitable to
transfer abroad” (Lall 1980: chapter 1). This ‘cyclical’ effect, therefore, partly
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negates the statistical results with respect to the nature of the relationship
between Research and Development and exporting or producing abroad. In
this regard, the fact that country-specific and firm-specific advantages also act
upon the decision of firms to export indicates that the relationship of Research
and Development to exporting or producing abroad is far from being a perfectly
linear relationship.
Scale economies are also expected to exhibit a ‘cyclical’ effect as productive
capacity first satisfies local demand before expanding overseas. The correlation
coefficients on this advantage are more strongly positive and significant for
foreign production as compared with those of exports when tested
Thus, firms that enjoy economies of scale in production
normally prefer foreign production to exporting (Lall 1980: chapter 1).
For each industry, SAL (the number of salaried employees as a percentage of
the total work force), PW ( the average production wage), and AW (the average
wage per employee) were the alternative measures used to approximate ‘skill’.
Lall’s findings are that the factor, average production wage, is significantly
correlated with exporting but not with foreign production.
In contrast, the
number of salaried employees as a percentage of the total work force is
significantly correlated to foreign production. Thus firms that have a relatively
large number of highly skilled salaried employees are more likely to engage in
foreign production than firms with a low skilled workforce whose skills are not
easily transferable abroad.
These results partially support the studies
hypothesis that certain employable skills are easily transferable abroad, these
transferable skills being high level salaried skills (Lall 1980: chapter 1).
AD (advertising expenditure) – a measure of the propensity for product
differentiation, had the expected positive correlation with foreign production.
Lall thusly suggests that the ability to differentiate products through significant
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expenditures on advertising gives firms that wish to invest abroad a significant
advantage over firms with less significant advertising budgets. Alternatively, KL
(capital intensity – measured as total net fixed assets in each industry divided
by the total number of employees) failed to reach significance on any of the
regressions. Furthermore, its sign changed erratically. It was found, therefore,
not to be a factor which is important in influencing foreign production (Lall 1980:
chapter 1).
Ownership-specific advantages are not exclusive to the market power
approach. Other theories take cognizance of these advantages, however,
affording them a lesser degree of relevance. The same can be said of other
advantages used to explain the motivating factors of foreign direct investment.
These include the location-specific advantages and internalization advantages.
Location-specific advantages
Location specific advantages as an explanation of foreign direct investment can
be discussed in terms of the following location-specific factors – availability and
cost of inputs, marketing factors, bypassing trade restrictions, and factors
related to government policies (Chen 1983:25-6). Thus, a firm investing abroad
may simply be attracted by the availability in another country of some inputs
which are very scarce at home, or by the lower cost of inputs abroad. This case
in point is often evidenced by a lower labor cost in the potential host countries.
There are usually also advantages of locating production near the market. In
doing so, the local market can be better explored, tariff barriers can be avoided,
local requirements can be more easily catered for, and transportation cost can
be reduced. It is sometimes also true that production via the setting up of
subsidiaries in a host country is more accepted by the local people than direct
exporting to that country (Chen 1983:25-6).
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With regard to the economic policies of host governments, subsidiaries are
often set up by an investing country firm in the host countries which are not yet
subject to trade restrictions. The products produced by these subsidiaries are
exported to those markets which have imposed restrictions on the exports of
the investing country firm. Lastly, a firm may be attracted to invest abroad
because another country offers advantages such as lower tax rates, better
infrastructure, greater political stability, and great scope for expansion and the
pursuance of corporation goals (Chen 1983:25-6).
Internalization advantages
Internalization advantages refer to the ability of firms to reduce the costs and
uncertainties of arms length transactions in the market by integrating business
operations with suppliers (backwards integration) and/or distributors (forward
integration) through mergers, acquisitions or green-field investment (Cantwell in
Pitelis & Sugden (eds.) 1991:24). Backward and forward integration can occur
in either the domestic or foreign markets, however, under internalization theory,
integration/internalization that takes place across national borders and is also
thought to be brought about by market imperfections (Lizondo 1991:71; Cf.
Chen 1983:31). Thus, for example, lower factor costs abroad would represent
a market imperfection as well as a location-specific advantage that would give
rise to internalization and thus foreign direct investment.
In this case, the
market that would be internalized is the low cost factor market in question.
In essence, internalization and foreign direct investment are expected to occur
when the net benefits of joint ownership across international borders exceed the
net benefits of external trading relationships (Dunning 1993:75).
internalization can be seen to be an attempt by the multinational enterprise to
seek gains from efficiency rather than seeking gains from extending market
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power and erecting barriers to competition (Cantwell ed. Pitelis & Sugden
Internalization theory has been criticized for focusing on the internal motives of
the firm to invest abroad, whilst giving only limited attention to external factors
such as government policy and regulation that may affect the benefits and costs
of internalization (Robock and Simmonds 1989:47; Cf. Lizondo 1991:72).
The Eclectic Paradigm
The eclectic paradigm proposed by Dunning (1993:76-86) recognizes the
inability of a single theory to provide a comprehensive explanation for foreign
direct investment by multinational enterprises.
The eclectic paradigm thus
attempts to tie together elements (with strong explanatory power) from each of
internalization) in order to offer a more dynamic and complete explanation of
foreign direct investment.
In support of Dunning’s work, Cantwell (Pitelis & Sugden (eds.) 1991)
emphasized the need for a diversity of approach for the following reasons.
First, international production may be resource-based, import-substituting,
export-platform or of the globally integrated kind, each of which raises
distinctive considerations and each of which affects home and host countries in
different ways.
Second, international production can be studied from three
different levels of analysis: macroeconomic (examining broad national and
international trends), mesoeconomic (considering the interaction between firms
at the industry level) and microeconomic (looking at the international growth of
individual firms).
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It should be noted that the eclectic paradigm is not an alternative international
production theory, rather it is an overall organizing paradigm for identifying the
elements from each approach which are most relevant in explaining a wide
range of various kinds of international production, and the wide range of
different environments in which international production takes place.
eclectic paradigm abstracts from the main theories the varying dynamics
between the advantages discussed above.
That is the ownership-specific
advantages denoted as (O), the location-specific advantages (L) and the
internalization advantages (I).
Thus, rather than emphasizing a specific
advantage as the key determinant of foreign direct investment, the eclectic
paradigm seeks to clarify the relationship between different levels of analysis
(macro, meso and/or micro) and the different questions to be addressed by the
analysis. For example, internalization theory may be the most relevant under
certain circumstances or when answering certain kinds of questions (such as
those related to backward vertical integration into resource extraction), while
locational advantages are the key variable studied in determining the firms
competitive strategy in it’s final product market (Cantwell in Pitelis & Sugden
(eds,) 1991:26).
In general, the eclectic paradigm asserts that if a firm possesses only
ownership-specific advantages but not (I) and (L), the firm will, inter alia, be
indifferent between the competing options of foreign direct investment,
exporting, and licensing. In theory, all three options will be equally viable. If,
however, the firm'
s ownership-specific advantages can be internalized, the firm
will prefer to either engage in foreign direct investment or exporting rather than
licensing. Further, if the firm possesses ownership-specific advantages which it
is able to exploit internationally as a result of locational factors/advantages
available in foreign countries, the firm will normally engage exclusively in
foreign direct investment as opposed to exporting or licensing (Chen 1983:33).
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The Economic Effects of FDI on the Host Country
Before dealing with the subject matter of the economic effects of foreign direct
investment occurring in host countries, it is necessary to first identify how the
term ‘economic’ is to be defined and used in the present context. The New
Merriam-Webster dictionary defines the term economic as the subject matter
which is concerned with “the satisfaction of material needs of humans” (The
New Merriam-Webster Dictionary). This definition can only serve as a partial
definition, as the term economic is associated with factors other than material
needs as proposed by Eatwell et al. (ed) (1987) in The New Palgrave: A
Dictionary of Economics. Eatwell et al. (ed) (1987) point out that even in the
pursuit of wealth (or alternatively, material needs), the term economic strongly
implies a fundamental need to avoid waste either of labor or of its produce even
where these may have no direct relationship to the production, distribution, or
consumption of wealth/material needs. Thus the term economy can be used in
diverse applications such as in mechanical engineering where the conservation
of energy is often referred to as the ‘economy of force’, and in project
management where ‘economy of time’ is used to signify an efficient allocation of
resources that has little or no direct relationship to the production of wealth or
the satisfaction of material needs (Eatwell et al. (ed) 1987). The economic
effects referred to in this section of the dissertation, shall refer to the usage of
the term economic in the broader context as set out by Eatwell et al. (ed)
(1987). Thus, for the purposes set forth for this dissertation, economic effects
will be taken to refer to monetary (e.g. gross domestic product and per capita
income) as well as non-monetary (e.g. employment and literacy) changes
occurring in a specified geographic area (domestic, international, regional etc.)
brought about by the entry of multinational enterprises into that geographic
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Compared to the theories proposed to explain the proliferation of foreign direct
investment in the form of multinational enterprises, the theories dealing with the
economic effects of the foreign direct investment of multinational enterprises in
host countries has received much less attention in the literature. Yet, however,
these latter theories are equally important policy determinants. The economic
effects of foreign direct investment occurring in the host country can be
examined from a number of analytical vantage points. Very generally, foreign
direct investment has economic implications for host countries that may be
associated with economic development, competitive market conditions, and
balance of payments effects (Muchlinski 1995:7-8; Cf. Dunning 1993:283).
Theory and empirical evidence to be reviewed in this section address each of
these factors in turn.
Economic effects of foreign direct investment of multinational
enterprises associated with development
Although the terms productive output, economic growth and economic
development are often used interchangeably in the literature, there are
important definitional nuances that serve to differentiate the terms from each
other. Failing to recognize the distinctiveness of these three terms and using
them interchangeably and indiscriminately will no doubt result in inconsistent
measurement of the economic effects of foreign direct investment (Kindleberger
and Audretsch 1983:21). In order to avoid this pitfall, the above-mentioned
terms will hereby be defined as follows (Kindelberger and Audretsch 1983:21-3;
Cf. Todaro 1981:56; Cf. Morgan and Gardner 1973:186):
(a) Productive output is essentially a static measure of productive activities.
Thus productive output is the measure of output obtained by a given
level of inputs as measured at a specific point in time.
University of Pretoria etd – Moeti, K B (2005)
(b) Economic growth (or it’s synonym output growth) can also be defined in
terms of output obtained from a specified amount of input, however,
economic growth is distinguished from productive output as it is a
dynamic (rather than static) measure of productive activities measured
longitudinally over a specified period of time.
The most common
measure of economic growth is a nation’s gross national product
adjusted for inflation; and lastly,
(c) Economic development is a far broader measure than both productive
output and economic growth in that it seeks to recognize factors other
than productive inputs and outputs in assessing the contribution of
investment to the local economy.
That is, economic development,
attempts to account for, among other factors, employment, literacy,
changes in institutional structures and in some instances even changes
in popular attitudes, customs and beliefs.
In keeping with the above conventions with respect to the definition given of
economic development, the effects of foreign direct investment on employment
will be explored under this section. Also, an important caveat to be addressed
before embarking on a discussion of the interactive nature of foreign direct
development is that as productive output and economic growth limit their
definitional scope to productive inputs and output they provide relatively simple
quantitative measures whose relationships can be resolved through expression
in mathematical form and are therefore readily subject to empirical
measurement and testing.
On the other hand, owing to the greater detail
required to characterize economic development, economic development
models are, by default, far less scientific than models of productive output and
economic growth and are therefore less amenable to mathematical formulation
and proof. The dichotomy lies in the fact that economic development models
add greater understanding to the issues at hand whilst at the same time
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compromising the scientifically verifiable nature of their findings (Kindleberger
Foreign direct investment and output growth
Initial attempts to assess the impact of foreign direct investment on productivity
levels and output growth within host countries made use of what are now
commonly referred to as neo-classical growth-theoretic models of the Solow
(1956) type (Herrick and Kindleberger 1983:70; Cf. Todaro 1983:34-9; Cf. De
Mello 1997:1). Under these growth models, it was assumed that diminishing
returns to physical capital would dictate that foreign direct investment could only
affect short run output growth while leaving long run growth unchanged. In
essence, the belief was that foreign direct investments initial contribution to
growth would diminish over time and thus the economy would return to it'
steady state growth path (Herrick and Kindleberger 1983:70).
Contemporary growth models as proposed by DeMello (1997) and others make
a case for taking account of endogenous variables that act as channels through
which foreign direct investment can be expected to promote growth in the long
run. Accordingly, foreign direct investment is expected to contribute to long-run
productivity growth by adding to the production functions of the host country
through the asymptotic growth catalysts of new inputs and advanced
technology. In the case of new inputs, output growth can result from the use of
a wider range of intermediate and final goods in foreign direct investmentrelated production. In the case of new technologies, foreign direct investment is
expected to result in productivity gains via spillovers to domestic firms.
(Feenstra and Markusen, 1994 cited in De Mello 1997).
In fact, De Mello (1997:10) further maintains that human capital augmentation is
the most important channel through which output growth takes place via foreign
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direct investment.
This is because the potential externality effects brought
about by knowledge and technology transfers are expected to be greater than
those related to the introduction of new inputs. The external effects associated
with foreign direct investment knowledge transfers are measured as the
augmentation of the existing stock of knowledge in the recipient country of the
foreign direct investment, by way of labor training and skills acquisition and
diffusion, on the one hand, and through the introduction of alternative
management practices and organizational arrangements on the other (De Mello
1997:10). It has thus been argued that human capital augmentation associated
with foreign direct investment is a significant endogenous variable in assessing
foreign direct investments impact on growth that has been factored out (or
overlooked) by classical models of international trade theory.
In essence,
under endogenous growth models, foreign direct investment is expected to lead
to technology or knowledge transfers which in turn bring about human capital
augmentation, the result of which is expected to be long-term process
innovations and increasing returns (De Mello 1997:8-9)
Through the use of regression and sensitivity analysis, Borensztein et al.
(1998:115-35) demonstrate empirically the relationship that exists between
foreign direct investment, economic growth and other variables that may tend to
affect economic growth either in conjunction with, or independently of foreign
direct investment. Essentially the same set of conclusions as those of De Mello
(1997) are reached by Borensztein (1998). Change in the average annual rate
of per capita gross domestic product (GDP) is used as the measure of
economic growth.
The Borensztein (1998) study was conducted by way of
examining investment flows from an unspecified number of developed countries
going into 69 developing countries during the decades of the 70’s and 80’s.
The results derived from the Borensztein (1998) study suggest that through
advanced technology transfer, foreign direct investment contributes relatively
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more to growth than does domestic investment. The caveat here being that
foreign direct investments contribution to growth can only occur in those cases
in which there exists a minimum threshold level of absorptive capability of the
advanced technology (this absorptive capability is proxied by a measure of the
level of educational attainment of the human capital stock) (Herrick and
Kindleberger 1983:70; Cf. Borensztein 1998:117). Ironically, the results derived
from Borensztein’s (1998) model indicate that foreign direct investment actually
decreases economic growth (estimated by gross domestic product) in cases
where the absorptive capability is below the threshold measure.
acknowledges that this is inconceivable in the real world and attributes these
anomalous results to attempts to model non-linear relationships in linear
equations. That is, x and y are most likely non-linear but for simplicity a linear
model is defined.
Additionally, Borensztein’s (1998) regression results indicate that foreign direct
investment on it’s own has a positive but minimally significant effect on
economic growth, whereas the interaction term which is the product of foreign
direct investment and human capital stock (available in the host country)
registers a positive and highly significant co-efficient. By testing foreign direct
investment and secondary school attainment (the measure of human capital
stock) individually alongside their product, Borensztein (1998) was able to
simultaneously test whether these variables affect growth by themselves or
through the interaction term. His findings indicate that neither foreign direct
investment nor human capital stock on their own are significant determinants of
economic growth, rather it is only when foreign direct investment is combined
with a minimum level of human capital stock that a statistically significant
contribution is made to economic growth (Borensztein 1998:123-8).
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2.5.1(b) Direction of causation between foreign direct investment and economic
A significant point of contention that has been addressed in the literature is the
issue of the direction of causation between foreign direct investment and
economic growth. Caution must be exercised in those cases where foreign
direct investment and economic growth exist in parallelism. In such cases it
cannot simply be concluded that foreign direct investment leads to economic
growth (or vice-versa) based solely on tests of correlation (Wells in Robinson
ed. 1987: 17; Cf. De Mello 1997:27; Cf. Caves 1996:224-6).
Although it has been argued that foreign direct investment leads to human
capital augmentation which in turn leads to economic growth, it has also been
argued that developing countries that have excellent growth prospects (prior to
significant foreign direct investments being undertaken in their economies)
simply tend to attract greater levels of foreign investment than those lacking
growth potential. In the case of the latter argument, positive and significant
domestic economic growth may lead to increases in income and purchasing
power of domestic consumers who may in turn attract market seeking foreign
investments. Additional growth related variables that may tend to attract foreign
investment include the trade regime and degree of macroeconomic stability in
the host country (De Mello 1997:27).
2.5.1(b)(i) Granger-causality technique
The Granger-causality technique has been proposed as a tool for determining
the direction of causation between foreign direct investment (FDI) and
economic growth (De Mello 1997:10-15). Granger causality is calculated as
∆g y ,t = a 0 + a1 ∆ FDI t +
i =1 i
c ∆g y ,t −i +
i =1
F i ∆ FDI t −i + ut , (1)
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∆ FDI t = b0 + b1 ∆g y ,t +
i =1
d i ∆g y ,t −i +
i =1
G i ∆ FDI t −i + vt ,
where g y is the rate of growth of output (economic growth), n and m denote the
number of lags chosen and u and v are standard error terms.
By this technique, and using formula (1), FDI is said to "Granger-cause"
economic growth if lagged (rather than current) values of FDI as well as lagged
values of the economic growth rate used in the formulation result in more
accurate estimates of the current economic growth rate (See also Borensztein
et al 1998:131-3).
That is, using equation (1), FDI Granger causes output
growth if a1 = 0 and F i ≠ 0.
Similarly, using formula (2), economic growth "Granger-causes" FDI if more
accurate estimates of FDI can be obtained from use of lagged values of the
economic growth rate as well as lagged values of FDI inflows in the specified
equation. Thus, by equation (2) output growth Granger causes FDI if b1 = 0 and
G i ≠ 0, and bi-directional Granger causality is obtained if a1 = b1 = 0 and F i ≠ 0
and G i ≠ 0.
Using the Granger causality technique for the five Latin American countries (i.e.
Brazil, Mexico, Venezuela, Chile and Colombia) that hosted most of the region'
foreign direct investment during the period 1970-91, De Mello (1997:28-9) found
that in all cases the direction of causation was dependent upon the recipient
s trade regime, ranging from import substitution to export promotion. In
the case of Brazil, capital accumulation and total factor productivity (TFP) tend
to precede economic/output growth, but the direction of causality between the
latter and foreign direct investment was indeterminate. For Chile, on the other
hand, foreign direct investment tends to precede output growth. The difference
in the findings for these two countries is attributed to the fact that during the
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period under study, Brazil pursued import substitution policies, while Chile had
a much more open trade regime which focused on export promotion.
2.5.1 (b)(ii) Investment development path (IDP)
An alternative approach to Granger-causality is that developed by Dunning
(1993:88-9) and supported by Narula (1996:chapter 2) and others which
proposes that the direction of causation between foreign direct investment and
economic growth can be explained by diagnosing a country’s investment
development path (IDP). It must be noted that Narula (1996) takes the terms
economic growth and economic development to be synonymous and uses them
interchangeably. This fact, however, has little or no bearing on the validity of
his thesis, as he explicitly expresses that economic development is proxied by
gross national product (GNP) per capita (Narula 1996:15), while elsewhere
gross national product is also commonly used as a measure of economic
growth (Morgan and Gardner 1973:186)(Supra. the definitions in section 2.5.1
above). Thus, if both economic development and economic growth are set
equal to gross national product, then economic development can be said to be
synonymous with economic growth.
The investment development path (Infra. Figure 2.1) is essentially an analytical
framework based on Rostow’s stages of growth model (Cf. Todaro 1981:58)
and modified to account for the dynamics of Dunning’s (1993) eclectic paradigm
(Supra Sect. 3.8).
Investment development path theory holds that, ceteris
paribus, all countries advance through five distinct stages of development, and
each of these stages affects the level of inward and outward foreign direct
investment. Thereafter, aggregated net changes in inward and outward foreign
direct investment will then move the country forward along it’s development
path (Narula 1996:12-19; Cf. Dunning 1993:88-9). The relationship between
foreign direct investment and economic growth as explained under investment
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development path theory is a symbiotic one in which the direction of causation
is a secondary issue to that of the conditions under which the simultaneous
occurrence of foreign direct investment and economic growth is observed
(Narula 1996:12-19).
Figure 2.1: The pattern of the investment development path
NOI - net outward investment ; GNP - gross national product
Adapted from Narula 1996:22
Economic growth can be mapped out as a country’s investment development
path. The investment development path is a normative rather than a positive
example of the expected interaction between the foreign direct investment of
multinational enterprises (NOI) and specified phases of economic development
assuming a free-market economy. The reality is that each country is expected
to have it’s own unique investment development path that is a function of four
main variables, namely their resource structure, market size, economic system,
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and government organization and regulation of economic activity (Narula
Similarly, according to the eclectic paradigm upon which the
investment development path is founded, the propensity of firms to engage in
international production (i.e. the foreign direct investment of multinational
enterprises) will be a function of three main variables namely ownership-specific
advantages (o), internalization advantages (I) and locational (L) advantages
(Supra Sect. 2.4).
The fundamental workings of the investment development path, on the one
hand, and the foreign direct investment of multinational enterprises on the other
as described by the eclectic paradigm, can be seen as two separate modalities
that work together in a single system of simultaneous equations, the interaction
of which seeks to resolve one or more unknowns about their interrelatedness
(Herrick and Kindleberger 1983:22-3).
Investment development path theory
accounts for these relations in a stages-of-growth approach as described
hereunder (assuming a free market economic system with some degree of
export oriented rather than import substituting government policy)(Narula
Stage one of the investment development path is characterized by low levels of
economic development and economic growth. There are few location based
advantages within the host country for foreign firms to exploit other than natural
resources and cheap unskilled labor.
This deficiency in location based
advantages may reflect inadequate domestic markets wherein
conditions are minimal because of the low per capita income, insufficient
infrastructure such as transportation and communication facilities and, most
important of all, a poorly educated, trained or motivated labor force. During this
stage, foreign firms will prefer to export to and import from this market rather
than to engage in foreign direct investment. Government policy towards the
conclusion of this stage is directed at reducing some of the market failures by
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providing infrastructure and upgrading human capital by way of increased
spending on education and training (Narula 1996: chapter 2).
In stage two, owing in part to the effectiveness of government policies in stage
one, inward foreign direct investment starts to rise, while outward investment
remains low or negligible.
Domestic consumption is also expected to
experience growth in terms of both size and purchasing power thus stimulating
some amount of market seeking inward foreign direct investment.
oriented inward foreign direct investment may also take place in those countries
that have and/or provide infrastructural support such as an adequate
transportation network, communication facilities and supplies of both skilled and
unskilled labor. Domestic firms may begin to close the technology gap that
exists between them and multinational enterprises as a result of government
policies regarding technology transfer and accumulation.
Although outward
foreign direct investment by domestic firms increases during this stage, it does
so at a rate that is by now insufficient to offset the rising rate of growth of inward
direct investment.
By the end of stage two, however, the growth rates of
outward direct investment and inward direct investment will begin to converge
(Narula 1996: chapter 2).
In stage three of the investment development path, the rate of inward direct
investment by foreign firms begins to decline while the rate of outward direct
investment of domestic firms rises. Consumers begin to demand higher-quality
goods as their incomes rise.
In response to consumer demands, labor-
intensive production of basic consumer goods by foreign and domestic firms will
decline as firms retool themselves for the production of high technology goods.
Outward foreign direct investment continues to increase as declining industries
(such as labor intensive ones) undertake direct investment abroad in countries
that are at lower stages of the investment development path (Narula 1996:
chapter 2).
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In stage four, the rate of growth of outward direct investment is still faster than
that of inward direct investment. In fact, a country is considered to be in stage
four of the investment development path when it’s outward direct investment
equals or surpasses it’s inward direct investment. Domestic firms are by now
able to compete both at home and abroad with foreign-owned firms owing to
higher rates of technology accumulation by domestic firms.
processes become even more capital intensive than at earlier stages of the
investment development path as the cost of capital will be lower than that of
labor. A significant proportion of inward direct investment in this stage is from
firms originating from other stage four countries and is of an asset-seeking
nature (i.e. natural assets and/or created assets). There is also expected to be
an increase in the amount of inward direct investment from countries at lower
stages of economic growth that is of a market seeking, trade related and asset
seeking nature (Narula 1996: chapter 2).
Stage five is the final stage in which net outward investment begins to fall back
as outward and inward investment become more balanced. In fact, stage five
countries will normally maintain a stable yet fluctuating equilibrium around a
roughly equal amount of inward and outward direct investment. This is the
scenario that is expected to occur in advanced industrialized nations. With
regards to inward direct investment in stage five, this is normally dominated by
two distinguishable modes of investment. The first will come from countries at
lower stages of the investment development path and will be essentially of the
market seeking and knowledge seeking type. The second will be from stage 4
(or stage 5) countries in the form of market seeking, asset seeking, and
efficiency seeking investment with greater emphasis on cross-border alliances,
mergers and acquisitions. It must be noted, however, that as firms become
more sophisticated global operators, their nationalities become blurred.
firms move with countries across the investment development path, they no
longer operate principally with the interests of their home nation in mind, as they
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trade, source and manufacture in various locations, exploiting created and
natural assets wherever it is in their best interests to do so. It is also expected
that during this the final stage of the investment development path, firms will
increasingly engage in intricate webs of trans-border cooperative ownerships
and governance (Narula 1996: chapter 2).
Economic effects of foreign direct investment associated with
Employment is an issue that has been argued on both sides of the debate on
the foreign direct investment of multinational enterprises.
That is, inward
foreign direct investment has been argued to contribute to a reduction of
unemployment by some whilst others have argued to the contrary.
More specifically, on the one hand, multinational enterprises can contribute to
local employment by creating service, supply and distribution linkages with local
On the other hand, the employment effect of multinational
enterprise investments may be negative if local businesses and employment
are effectively '
crowded out'by multinational enterprises who do not create
linkages but instead enter into direct competition with local businesses (Caves
1996:115-20; Cf. Muchlinski 1995:91; Cf. Daniels and Radebaugh 2001:385-7).
Still others have further argued that given that multinational enterprises in
general have the potential to affect employment within the host country, policy
on multinational enterprises should ensure specified amounts of local
participation in their business ventures. In fact a number of countries (mostly
third world) have indeed incorporated such requirements in their foreign direct
investment policy agendas (Muchlinski 1995:104, 177-181).
Chen (1983) examines the two characteristics of firms, the choice of technology
and the propensity to export, as probable channels through which multinational
University of Pretoria etd – Moeti, K B (2005)
enterprise’s foreign direct investment leads to employment creation. These will
be considered hereunder.
2.5.2 .(a)
Choice of technology and employment
With regard to choice of technology, Chen (1983:Chapter 5) argues that the
wrong choice of industrial technology by firms can have employment
More specifically, technologically advanced and capital-
intensive investment will tend to either have no effect on employment or lead to
a reduction in employment, whereas increased employment is expected to
result from labor-intensive technology investment. Further, it is also argued that
multinational enterprises generally use more capital-intensive and less laborintensive technologies than local firms (Chen 1983:102). This contention is
supported by a number of rationalizations including the following:
First, technological differences between countries and their firms may make
it expensive for foreign firms to adapt or modify their technological
processes to be more appropriate for host countries.
Second, foreign firms/multinational enterprises tend to experience different
factor costs from local firms such that they pay higher wage rates to their
workers and also normally have better access to international credit. Such
factor price conditions would result in their operations being more capital
intensive and less labor intensive.
Third, when faced with a trade-off between instituting labor intensive
methods and profit maximization, firms (local and foreign) would normally
opt for profits at the expense of labor unless otherwise coerced by
government policy.
It should be noted, however, that the empirical evidence on the issue of capitallabor choices of multinational enterprises is rather inconclusive. That is, there
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are as many studies that support the hypothesis that multinational enterprises
tend to use more capital intensive technologies (than local firms) as there are
studies that refute this hypothesis (Chen 1983:103-4). These disparate findings
may be the result of the differences in sample countries, industries and firms
studied as well as differences in methodological approach of the studies.
2.5.2 (b)
Exports and employment
The propensity of firms (both local and foreign) to export has also been shown
to lead to employment generation (Chen 1983:Chapter 6). In accordance with
the eclectic paradigm (Chen 1983:32-5; Cf. Dunning 1993:76-88; Supra Sect.
2.4), foreign firms choose to invest in host countries whose comparative
advantages (i.e. locational advantages) are compatible with their firm specific
advantages (i.e. ownership and internalization advantages) and therefore
foreign firms may contribute more to production, employment and exports than
do local firms. The argument is that if foreign firms invest in industries in which
the host country has a comparative advantage, these foreign firms will in fact
promote a more efficient use of resources in the host country and concomitantly
increase the output and export of manufactured goods of the host country. This
increase in output and exports can only be attained through increased
Thus, based on this argument, multinational enterprises are
expected to contribute more to employment than local firms.
One is cautioned, however, in making this argument unreservedly. Rather, a
more competent application of this argument can be made by taking account of
all possible counter factual arguments (Dunning 1993:366).
There are a
number of possible counterfactual scenarios to the expected foreign direct
investment of a particular firm - for example, a different foreign firm from the
same or a different country may make the investment in place of the firm under
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analysis; local firms may make the investment where foreign firms fail to act; or
no investment may take place at all.
The employment outcome expected with the foreign direct investment of the
multinational enterprise must be compared with the employment outcome
expected if the foreign direct investment in question had not been made. The
algebraic difference between these two estimated employment outcomes is the
more accurate measure of the employment contribution of the foreign direct
investment (Dunning 1993:366). Additionally it is recommended that sensitivity
analyses be performed on further counterfactual variables such as the type of
investment made, the anticipated response of competitors and the policies
pursued by home and host governments (Cf. Robock and Simmonds
Foreign direct investment and economic development in the South
African context
From the discourse thus far covered in the present chapter, it can be
ascertained that foreign direct investment plays no small role in contributing to
the development of a nation and the well-being of it’s peoples. Although public
as well as domestic private investment has kept South Africa’s major industrial
cities apace with the infrastructural development standards of the worlds
leading industrialist countries; unemployment, illiteracy, and poverty are at odds
with these achievements (1996 census data cited in South Africa Yearbook
1999:4-17; 1996 census data cited in Mataboge 1999:199-202).
In general it has been stressed that a government’s foreign direct investment
policy should be consistent with the development plans of that government
(Modelski 1979:313). Thus, for example, foreign direct investment policies that
encourage mineral extraction may be counter to development goals as “…they
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may generate few processing industries or do little to raise the level of local
skills”(Modelski 1979:313). At the current point in South Africa'
s development,
the government is currently engaged in a re-assessment of growth and
development macroeconomic strategies with specific reference to the role to be
played by the private sector (both domestic and foreign) in partnership with the
public sector.
In this regard, the medium term goals of the government’s
macroeconomic strategy include promoting the following (South African
Yearbook 1999:311):
(a) A competitive fast-growing economy that creates sufficient jobs for all
work seekers;
(b) A redistribution of income and opportunities in favor of the poor;
(c) A society in which sound health, education and other services are
available to all; and,
(d) An environment in which homes are secure and places of work are
The South African National Budget continues to give priority to spending on
education, health, welfare and social infrastructure, whilst exercising measures
to reduce government debt (for example, through privatization) in an effort to
increase both private domestic investment and foreign investment (South Africa
Yearbook 1999:311).
Additionally, the government has committed itself to
development levy that came into effect in April 2000 under the Skills
Development Levies Act 1999 (Act 9 of 1999). The skills development levy is
aimed at financially supporting sectoral education and training initiatives
through the payment of a 1 percent payroll levy by all employers falling under
the ambit of the Act (South Africa Yearbook 1999:311).
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2.5.4. Economic effects of multinational enterprises foreign direct investment
associated with competitive markets
As discussed above, an analysis of the economic effects occurring within the
host country of foreign direct investment by multinational enterprises may be
conducted under one of two possible assumptions – i.e. perfect markets or
imperfect markets (Parry in Hawkins (ed.) 1979:63-5; Cf. Chen 1983:16-7; Cf.
Muchlinski 1995:33-8). Under the analytical assumption of perfect markets,
capital (foreign direct investment) is assumed to move from countries with low
returns to capital to countries that offer higher returns (for example- due to
currency and/or interest rate differentials between home and host countries).
This shift in capital is assumed to be unimpeded and is therefore further
assumed to result in gains to both the host and home countries as a result of a
more efficient global allocation of capital. The assumption of perfect markets,
however, is far less realistic than that of imperfect markets especially with
respect to explaining the existence and proliferation of multinational enterprises.
In this regard, there is much greater empirical support for theories that take
account of market imperfections such as barriers to entry and monopolistic or
oligopolistic market structures. In fact, the contemporary theory of multinational
enterprises (the market power approach and the product cycle theory for
example) strongly argues that market imperfections are indeed a necessary
condition for domestic firms to become multinational enterprises (Hymer 1960;
Cf. Vernon 1966 cited in Hawkins ed. 1979:63-5; Cf. Dunning 1993:429). The
competitive market effects of the foreign direct investment of multinational
enterprises may be observed, ceterus paribus, through changes in industry
structure. The dynamics of these possible changes in industry structure are
discussed hereunder.
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2.5.4 (a)
Foreign direct investment of multinational enterprises and Industry
The economic effects of multinational enterprise investment, occurring within
the host state, can be assessed in-dept by focusing on the changes in industry
structure (Parry in Hawkins ed. 1979:65; Cf. Caves 1996:224-7). In fact the
very nature and characteristics of multinational enterprises will determine the
nature of their effects on host countries. That is, given that (by definition) the
multinational enterprise is a firm that has operations in more than one country, it
follows that decision-making within any given multinational enterprise operation
cannot always be on its on terms, but rather must take account of global
multinational enterprise objectives and global decision-making on the part of the
parent company.
This global focus of the multinational enterprise is what
distinguishes it from the domestic firm in terms of isolating those economic
effects that can specifically be attributed to the multinational enterprise
investment within the host country. Thus, an example of a global multinational
enterprise objective that may have economic consequences for a given host
government is the ‘restrictive export franchise’ which requires a given subsidiary
to not compete in certain export markets reserved for other affiliates of the
multinational enterprise group.
This type of constraint may well benefit the
multinational enterprise group but will usually have negative effects within the
host economy of the subsidiary by way of dampened industry export
performance (Parry in Hawkins (ed.) 1979:65-6; Cf. Muchlinski 1995:387-393).
Additionally, anti-competitive characteristics are inherent in the nature of the
multinational enterprise as its global access to capital and advanced technology
will allow the multinational enterprise subsidiary to enjoy advantages of
monopoly power over and above those available to domestic firms in the host
market. Although the aforementioned monopolistic advantages gained by the
multinational enterprise subsidiary may result in increased productivity and
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lower consumer prices in a given industry, these benefits may be substantially
transferred out of the host country generally as a result of the global basis of
decision-making on the part of the parent multinational enterprise and more
specifically through transfer-pricing practices (Parry in Hawkins (ed.) 1979:66;
Cf. Dunning 1993:512-15).
Transfer pricing practices refers to the overstatement of the cost of input and
intermediate products acquired by the MNE from an affiliate within the same
MNE group/company. This accounting overstatement results in a loss of tax
revenue to the host country and an unwarranted tax savings to the MNE which
may be transferred out of the host economy in the form of retained earnings
and dividends (Parry in Hawkins (ed.) 1979:66; Dunning 1993:512-15). Further
effects of MNE transfer pricing are the distortion of prices of final products and
the resultant inefficient resource allocation within the host industry (Parry in
Hawkins (ed.) 1979:66).
The empirical evidence on the effect of MNE investment on the host industry
structure suggests that MNE affiliates tend to hold monopoly power in the host
markets in which they operate as measured by the relative size of MNE
subsidiaries against the size of local firms in both developed and developing
countries (Parry in Hawkins ed. 1979:67; Caves 1996:225). This was found to
be the case for United States multinationals in both developed and developing
countries as well as for MNEs (regardless of country of origin) in Canada and
Australia (Parry in Hawkins ed. 1979:67). Further, it has also become evident
that many of the host industries in which MNEs cluster tend to be highly
concentrated, perhaps reflecting the structure of the home-country industry.
This is indeed the basis for the argument that MNE investment often creates
adverse ‘branch-plant structures’ within the host market by replicating, in the
host country, the structure of the home-country industry.
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2.5.4 (b)
The technology of multinational enterprises and industry structure
Relative technological advantage, as measured by research and development
(R&D) expenditures, is yet another important mechanism through which the
multinational enterprise entering a host market can create market imperfections
in that host industry (Muchlinski 1995:429; Cf. Caves 1996:229-31; Cf. Dunning
1993:436). The resulting market imperfections, in turn, then have important
implications for industry structure. This is a two stage process that involves
firstly the creation of monopoly market power by the multinational enterprise
through the exercise of it'
s proprietary rights over it'
s technology either in the
transfer of that technology to local partner firms or by using the technology
itself. In the second stage of this two-stage process, the market imperfections
created will normally have measurable consequences for the host industry
structure by way of the size and number of firms competing in the industry after
the multinational enterprise entry has taken place (i.e. market concentration)
(Parry in Hawkins (ed.) 1979:71-5; Cf. Dunning 1993:431). The transfer of
technology to the multinational enterprise’s affiliate or to local firms is
considered to be an ‘inappropriate’ form of technology transfer where the MNE
simply adapts to the host industry, home market technology and equipment for
which factor costs (labor and capital inputs) differ markedly from those of the
host country (or industry). This may lead to a less than optimal scale of plant
production by the multinational enterprise in relation to the market size of the
host country (Caves 1996:229-31; Muchlinski 1995:429-31). In addition, in the
situation in which the initial investment by the MNE is followed by the entry into
the host market of other multinational enterprises as competing international
oligopolists, the expected outcome will in all likelihood be a highly fragmented
industry structure consisting of high-cost, underutilized plants and an inefficient
allocation of resources in the host industry (Parry in Hawkins (ed.) 1979:71-5).
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The terms and costs under which technology is transferred by the MNE are the
basis upon which technology represents a major source of monopoly or
oligopoly power in the host industry (Parry in Hawkins (ed.) 1979:71-5). These
terms and costs normally take the form of tie-in clauses that place restrictive
requirements on the use of the technology or ‘know-how’ by the subsidiary or
local partner and in some cases restrictive requirements may be extended to
also impose limitations on their purchasing and export policies as well (Parry in
Hawkins (ed.) 1979:71-5). Further, this potential of the multinational enterprise
to create monopoly power through terms and costs attached to technology
transfer is not strictly intrinsic to the multinational enterprise, but it is also often
reinforced by existing patent laws within both host and home countries. The
combined result, thereof, is that the monopoly element that may be exploited by
the multinational enterprise in the process of technology transfer presents an
important constraint on host nations gains from inward investment (Parry in
Hawkins 1979:71-5).
2.5.4 (c)
Form of multinational enterprise market entry and industry structure
The impact of the foreign direct investment of multinational enterprises on
industry structure is also partly dependent on the form in which this market
entry takes place. Multinational enterprise market entry can occur in either of
three ways – green-field entry, take-over or merger. Each one of these three
modes of entry may potentially result in a change in the size and number of
firms in the industry in question, which equates to a change in industry
concentration and/or industry structure (Parry in Hawkins 1979:71-5; Cf.
Dunning 1993:431).
A concise definition of a green-field entry, of which will constitute the prescribed
definition to be used throughout this dissertation, is that given by Hoogvelt and
Puxty (1987:109) as “Investments involving the establishment of new firms,
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especially new factories or other physical assets, as opposed to the acquisition
of existing establishments.” The multinational enterprise that enters an industry
through a green-field investment will initially increase the number of firms in a
given industry, thereby reducing seller concentration and positively affecting
industry structure through increased competition. However, this circumstance
may and often does change when the multinational enterprise becomes
established in the industry (Parry in Hawkins ed. 1979:71-5; Cf. Dunning
1993:432-3). In this regard, it is important to note that long-term structural
changes in the industry occurring after the entry of the multinational enterprise
are largely independent of the form of market entry. This being noted, the
possible short-run counterfactual outcomes of a green-fields multinational
enterprise entry (where it is assumed that the multinational enterprise
possesses monopolistic or oligopolistic advantages over domestic firms) may
be that (Parry in Hawkins (ed.) 1979:71-5):
(a) Established firms may either be displaced or induced to merge in the
face of multinational enterprise entry, and/or;
(b) Marginal firms may be forced out of the industry and some of the
remaining indigenous firms may be forced to merge in order to
compete with the new entrant.
Industry structure is expected to become more concentrated where firms
(established or marginal) are forced out of the industry following an
multinational enterprise green-field entry.
This displacement of indigenous
firms has implications for allocative efficiency, the term allocative efficiency
being defined here as the efficient allocation of factors of production (labor,
capital and technology) to their most productive uses such that aggregate factor
productivity is optimized (Parry in Hawkins (ed.) 1979:85-7; Cf. Dunning
1993:417-20). Accordingly, where the majority of firms exiting the industry are
inefficient marginal competitors, allocative efficiency in the industry is improved.
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However, where efficient established firms exit the industry, allocative efficiency
is diminished (Parry in Hawkins (eds.) 1979:85-7).
Where the multinational enterprise entry takes place through either take-over or
merger with an established firm there will be no net change in the number of
firms, unless the take-over or merger involves more than one established firm
(Parry in Hawkins 1979:85-7).
However, even if the number of firms in an
industry remains unchanged thereafter, industry concentration and structure
may still be altered due to the effects of having a new dominant firm in the
industry that will most likely be able to create or amplify market imperfections
such as barriers to entry.
Empirical evidence indicates that multinational enterprises tend to engage more
frequently in mergers and takeovers in developed host nations than their
indigenous counterparts (Parry in Hawkins 1979:72). Whereas, on the other
hand, the principle form of entry by multinational enterprises into developing
host industries is through green-field investment (Parry in Hawkins 1979:72).
Policy implications of regulating multinational enterprises to ensure
competitive markets
The policy implications of regulating multinational enterprises to ensure
competitive markets are relatively evident in anti-trust laws as well as in
technology transfer laws and policies.
The discussion that follows explores
these two area of policy.
2.5.5 (a)
Anti-trust regulation
Where industry structure is characterized by in-efficiently high levels of industry
concentration, the regulation of multinational enterprises through anti-trust law
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should be considered (Muchlinski 1995:384-6; Cf. Daniels and Radebaugh
2001:389-90). In the exercise of anti-trust laws under such circumstances, it is
important to acknowledge that anti-trust laws should not, and normally do not,
differentiate between
foreign and domestic firms.
characteristics of the multinational enterprise may require special treatment
under anti-trust legislation.
These characteristics reflect the international
market power possessed by the multinational enterprise and its ability to
develop international networks of production and distribution in what are often
concentrated global markets (Muchlinski 1995:386-7; Parry in Hawkins (ed.)
1979:66-7). Thus, since multinational enterprises come into being as a result of
market imperfections that give them a competitive advantage over domestic
and/or single country firms vis-à-vis the internalization of markets in
intermediate products across national boundaries, the industries in which
multinational enterprises are present tend to be highly concentrated and
multinational enterprises also tend to be the dominant firms in those industries.
This process in particular leads to the development of characteristics in the
multinational enterprise which are consistent with several significant barriers to
entry into industries, such as (Muchlinski 1995:386):
(i) Engaging in high cost advertising;
(ii) Operating in industries where there are high capital costs to entry; and
(iii) Engaging in high cost research and development.
Moreover, where the multinational enterprise has put into place an international
network for the distribution of its products through subsidiaries or through
independent distributors, anti-trust regulation will be focused on the anticompetitive nature of any restrictive conditions that may be placed by the
multinational enterprise on its controlled or independent distributors.
restrictive conditions in question may include, for example, binding the
distributor to an exclusive contract in which the distributor may only distribute
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the products of the multinational enterprise, while also limiting the distributors
sales to a specified geographical territory. Across international boundaries this
type of restrictive condition may result in the partitioning of world geographical
markets by multinational enterprises effectively isolating them from competition
originating from distributors, or third parties, operating outside the relevant sales
territory (Muchlinski 1995:387-393; Cf. Parry in Hawkins 1979: 79-83; Cf. Chen
2.5.5 (b)
Regulating technology transfer
As foreign direct investment by the multinational enterprise normally takes place
as a package of collective inputs (such as technology, management, capital
etc.), the degree of indivisibility of this investment package has the effect of
creating monopoly power for the investing multinational enterprise, especially
with respect to technology transfer (Muchlinski 1995:427-431; Cf. Parry in
Hawkins 1979:68-71). That is, the collective nature of the investment package
may limit or exclude potential competition in markets for individual inputs. Thus,
the market for technology will be monopolized by the multinational enterprise to
the extent to which that technology is supported by the other inputs making up
the collective investment package (Muchlinski 1995:427-431; Cf. Parry in
Hawkins 1979:68-71). Technological advantage also creates monopoly power
when it is used to limit competition by restrictive conditions on the recipients of
the technology (Parry in Hawkins (ed.) 1979:68-71; Cf. Chen 1983:69).
Antitrust laws can also be used to control the multinational enterprise monopoly
element inherent in technological advantage and technology transfer. However,
in addition to antitrust law many Less Developed Countries (LDCs) have
developed a highly specialized and separate body of law referred to as
technology transfer law that, unlike antitrust law, takes account of policy factors
that go beyond regulation through competition policy. In fact, the essence of
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technology transfer law is to ensure that transferred technology is appropriate to
and benefits the host country usually with respect to development; development
being defined here as in section 2.5.1 above (Muchlinski 1995:442.; Cf. Parry in
Hawkins (ed.) 1979:70; Cf. Weinstein in Modelski ed. 1979:345-6).
The use of technology transfer laws has met with significant resistance in the
negotiations in the Uragay Round of the General Agreement of Tariffs and
Trade (GATT) (Muchlinski 1995:254-7). This controversy stems from the fact
that technology transfer laws may be interpreted as posing a challenge to laws
on the intellectual property rights of technology transferors in a number of ways.
Firstly, by regulating the terms of transfer, host states do not allow the
technology transferor to earn monopoly rents on their technological innovations.
Secondly, technology transfer laws may infringe upon the foreign patents and
trademarks owned by the transferor through the imposition of performance
requirements instituted by the host state. And thirdly, in principle, technology
transfer laws generally do not afford foreign investors the same treatment and
protection afforded indigenous firms in respect to intellectual property rights
(Muchlinski 1995:443-4).
In determining how to proceed with policies that address monopoly creation
through technology transfer, host governments are often faced with the
dilemma of balancing the interests of the multinational enterprise investor,
whose Research and Development commitments are grounded in the
expectation of monopoly rents from the transfer or exploitation of it’s
technological innovations, with the host governments interests in ensuring
technology diffusion into the industry and economy while also protecting
technology transferees and other market participants from unfair competitive
practices. Thus, policy makers who choose to deny multinational enterprises
full monopoly rights over their technological innovations run the risk of creating
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a disincentive for technology-based foreign investment into their countries
(Muchlinski 1995:442; Parry in Hawkins ed. 1979:68-71).
Balance of payments effects of foreign direct investment
A country’s ‘balance of payments’ refers to the net balance of financial
transactions (both private and public) that a given country has with the rest of
the world.
In other words, the balance of payments is calculated as the
difference (or net balance) between financial inflows from foreign sources into a
country versus domestic financial outflows accruing to foreign countries. This
measure does not take into account financial flows that occur between citizens
within the same country (Klein 1986:504; Cf. Robock & Simmonds 1989:319-
The payments and receipts that make up the balance of payments account are
usually not in balance as individual investors and borrowers enter into
international transactions to advance their respective self-interests without
regard to the choices of other individuals or the net balance of any country’s
balance of payments account (Klein 1986:504).
The balance of payments account is considered to be in deficit when
expenditures made by domestic residents’ abroad are greater than receipts
from other countries. A persistent balance of payments deficit normally leads to
a decline in the value of a country’s currency relative to other countries. Such a
currency decline is normally corrected through the use of monetary policy
instruments (Klein 1986: 504, 250-76; Cf. Dunning 1993:385).
In considering the balance of payments effects of foreign direct investment,
Hufbauer and Adler (1968 cited in Dunning 1993:392-5) approached the
analysis by assuming three possible outcomes or counterfactuals. These they
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called the classical, the anti-classical and the reverse classical substitution
The classical substitution model postulates that domestically held financial
capital that is invested abroad results in a net addition to capital formation in the
foreign host country receiving the investment and is thus an improvement to
that country'
s balance of payments, while on the other hand, that same
investment represents a net capital outflow and a decrease to the balance of
payments of the home country. In other words, under the classical substitution
model, foreign direct investment is an improvement to the balance of payments
of the host country at the expense of the home country.
Alternatively, the reverse classical assumption proposes that foreign direct
investment has no effect on the balance of payments of either the host
(recipient) or home (originating) country of the investment.
Under this
hypothesis, foreign direct investment merely displaces domestic investment that
would otherwise have taken place in the host country while at the same time
causing no change in capital formation in the home country.
Lastly, the anti-classical model assumes that foreign direct investment improves
the balance of payments of the host country by increasing plant capacity there
whilst leaving the balance of payments and plant capacity unchanged in the
home country.
The anti-classical approach differs fundamentally from the
above mentioned models in that no substitution is assumed to take place at
home or abroad. That is, under this approach, foreign direct investment is a net
addition to global capital formation, whereas with the classical substitution and
the reverse classical models foreign direct investment is assumed to merely
shift investment resources between home and host countries without changing
the global volume of investment.
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Determining which of the three models to use for analyzing the balance of
payments effects of foreign direct investment is further dependent upon the
assumptions made regarding the macro-economic policy objectives of both the
home and host country as well as assumptions pertaining to strategic options
and behaviors of investing firms.
Lall and Streeten (1977) produced some empirical work on the balance of
payments effects occurring within a host country as a result of foreign direct
investment. Data was collected from 159 multinational enterprises with
investments in six developing countries (Columbia, India, Iran, Jamaica, Kenya
and Malaysia) between 1970 and 1973.
The direct and total balance of
payments effects for each firm were examined, with the direct effects being
defined as those effects that have an immediate impact on the foreign
exchanges (Lall and Streeten 1977:130).
In addition to examining the balance of payments effects of particular case
studies of foreign direct investment, Lall and Streeten augmented their analysis
of the net effects of FDI by comparing these effects with three possible
counterfactual scenarios associated with the case in which the foreign direct
investment under study does not take place.
These they called the ‘import
substitution’ scenario, the ‘financial replacement scenario’, and the ‘most likely
local replacement’ scenario (Lall and Streeten 1976 cited in Dunning 1993:399).
According to the import substitution scenario, the assumption is that imported
goods would substitute for foreign direct investment in the host country. Using
this assumption, the balance of payments effect is calculated as the difference
between the foreign exchange generated by the foreign direct investment and
the foreign exchange that would have been spent on the imported goods
assuming the absence of the foreign direct investment. The second approach –
the ‘financial replacement’ scenario – assumes that locally-owned firms would
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have made similar investments to those of the multinational enterprise under
study. In this case, the net balance of payments effect is adjusted to reflect the
difference between the costs of capital faced by the domestic firms and the
foreign firm.
The third scenario, the '
most likely local replacement'scenario
attempts to calculate and make an allowance for that portion of inward foreign
direct investment that is not readily substituted or replaced by domestic
Lall and Streeten (1977) devised a composite index based on technological and
entrepreneurial capabilities of host countries to assist in determining the most
appropriate of these scenarios to use for given investments.
Using this
approach, Lall and Streeten (1977:Chapters 7 and 8) found that the direct
balance of payments effects of sample firms was negative in all of the surveyed
countries except Kenya. In the case of Kenya, inward investment was found to
be beneficial to the direct balance of payments no matter which of the three
scenarios was assumed. However, Kenya was not considered to be a typical
host developing country, since an above average number of foreign firms there
were export oriented (Lall and Streeten 1977:132).
In Latin America, Vernon (1973 cited in Dunning 1993) found that, inward
foreign direct investment has a positive effect on the balance of payments
account for a given sample of firms, unless it is assumed that the goods and
services arising from the investment would have otherwise been imported.
Biersteker (1978 cited in Dunning 1993) obtained similar results for a sample of
foreign firms in Nigeria.
In order to understand the policy implications faced by governments with regard
to inward foreign direct investment, it is essential to review the theoretical,
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empirical and even anecdotal evidence on the expected long-run effects of this
type of investment that may occur within the host country.
In this regard,
macro-economic variables (employment, the balance of payments account, and
the structure of the market) that are hypothesized to be affected by foreign
direct investment have been analyzed.
Chen (1983) proposed that foreign direct investment affects employment
through either of two channels - the choice of technology used and/or export
The nature of this relationship is that technologically advanced
foreign firms have little or no positive effects on employment, whilst the
propensity of foreign firms to export is significantly positively correlated with
These findings, however, are somewhat inadequate as they
simply allude to the total number of jobs created rather than bringing into the
analysis more subtle but important criteria such as the quality of jobs, whether
there has been a trend to more or less skilled employment, the level of
expatriate employment, training, and the indirect employment effects brought
about through sub-contracting.
As to the balance of payments, a host state'
s balance may be improved by the
inflow of new capital represented by a direct investment. However, this initial
effect is countered by the long-term outflow of capital through repayment of
loans and through dividend remittances. A balance of payments deficit would
be recorded in circumstances in which these financial outflows exceed the initial
With regard to the competitive effects of foreign direct investment on the host
economy, it is often asserted that multinational enterprises will spur domestic
firms into greater efficiency by exposing them to new competition. However, in
the absence of significant spill-over effects that make new techniques available
to local firms, and in the absence of adequate investment capital for local firms
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to develop, the net result may be that the foreign firm will drive the local
competition out. Given the highly concentrated nature of many of the markets
in which multinational enterprises operate, significant anti-competitive effects
may result.
Complicating the evaluation of the effects of foreign direct investment on the
host country, is the necessity for quite subjective assumptions to be made as to
most likely state of affairs given the absence of foreign direct investment. That
is, effects can only be meaningfully measured by comparing a state of being
with some explicit alternative. Thus, to measure the effects of the foreign direct
investment one has to assume what would have happened in the host country if
this investment had not been made. Past efforts to measure the effects of
foreign direct investment have demonstrated that the results are quite sensitive
to the assumptions made.
In addition to examining specific economic effects of inward foreign direct
investment, it is also crucial for the policy process that an understanding be
cultivated of the factors that motivate a national firm to choose to become multinational in scope. To this end, the theoretical literature reviewed in this chapter
also deals with explaining the existence and proliferation of foreign direct
Theories of the multinational enterprise and foreign direct
investment gained momentum in the 1960'
s with the comprehensive works of
Hymer (1960, 1968, 1976), Coase (1937, 1960), Knickerbocker (1973) and
others whose concerns centered around market imperfections and the possible
disruptive forces of foreign multinational firms in developing countries.
One of the major justifications put forward for the essentiality of multinational
enterprise policy is related to the issue of their tendency towards restricting
competition in the industries and markets in which they operate. To this end, a
number of conclusions can be drawn from what has been theoretically and
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empirically demonstrated in the literature. Caves (1988), for example, argues
that multinational enterprises are prevalent in industries with high levels of
concentration simply because the factors that give rise to entry barriers and
thus high concentration are the same factors that give rise to the multinational
enterprise form of business. Knickerbocker (1973) reached a similar conclusion
through empirical
testing, showing that
a correlation exists between
multinational enterprises and market concentration.
Of all of the studies surveyed, none was able to establish directional causation
between the foreign direct investment of multinational enterprises and market
concentration. Thus, based on the inconclusive nature of the evidence it is
doubtful that this issue by itself is enough to establish grounds for the
justification of a separate regulatory regime for multinational enterprises.
more realistic and limited approach to giving the issue some consideration in
the formulation of foreign direct investment policy specific to multinational
enterprises is to explicitly take account of the fact that multinational enterprise
investments should take place in a legal environment that is characterized by a
well developed competition and anti-trust policy regime. It may be difficult to
discriminate against foreign businesses on this or any other basis; however, an
awareness of the potential for abuses of a dominant position can at minimum
be addressed through improved monitoring in the foreign direct investment
policy framework.
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Chapter 3
Historical Perspective of South Africa’s Investment Climate
The context and relevance of the current chapter to the rest of the dissertation
is to a great extent proxied by the following statement taken from Maylam
“…an underlying assumption of this history is that there exists a
constant interplay between the past and present. People’s views about the
present state of affairs in South Africa must inevitably contain in-built
assumptions about South African history.
Similarly, present preoccupations
and concerns determine to a considerable extent the way in which the past is
approached and studied.”
In more specific and narrower terms, it can be shown or at least argued that the
general pattern and course of historical events, transitions and adaptation offers
an instructive synopsis of why things are as they exist today. In this regard, the
current chapter firstly sets out to view the investment environment and it’s
attendant policy from the beginnings (pre-industrialization and industrialization)
in South Africa in order to set the
context/framework within which the country’s current policies on foreign direct
invest can be assessed and critiqued.
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Within this same analytical framework, the chapter further endeavors to formally
explore the relatively intuitive yet complex assumption that business entities
operate in an environment that is wholly dependent on the social, political, legal
and economic vicissitudes of the day. In fact, and especially in the case of
foreign owned companies these four environmental forces can be expected to
have a significantly greater impact on business performance than is the case
with domestic firms. Ultimately, at the extreme, business performance is no
longer the issue. The issue advances from one of performing well to one of
being able to remain an on-going concern as foreign businesses may be
constrained to the point of not being allowed to continue operations in host
countries. This point is supported by what has been evidenced globally in a
number of cases where multinational enterprises were subjected to corporate
nationalization and also in those cases where multinational enterprises, as one
of the principal instruments of political and economic embargos, were forced to
suspend or terminate their subsidiary operations in host states. The latter of
these two cases is indeed the precedent in the South African historical context.
Lastly, given that current circumstances are to some extent influenced and
shaped by past events and circumstances, a central and underlying point
considered throughout the discussion of this chapter is the point that - perhaps
as a result of historical labor relations, socioeconomic turmoil, and the
embargoes during the latter part of the apartheid era, South Africa’s existing
foreign investment policies may reflect a certain openness to foreign investment
that compensates or perhaps even over-compensates for those prior hardships.
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As in the case with most of the world’s other societies or societal divisions, the
cycles and patterns of investment (both foreign and domestic) and development
in South Africa moved from agrarian to industrial to information technology.
However, the distinctive characteristic of South Africa'
s history that influenced
every aspect of societal life including the stages of investment and development
is the system of racial discrimination that came to be known as apartheid. The
South African Government used apartheid not only to further the political and
social interests of white Afrikaner citizens, it also used apartheid as a
springboard for industrialization and development to serve the ends of white
economic empowerment (Lowenberg and Kaempfer 2001:33; Cf. Fine and
Rustomjee 1996:63; Cf. Maylam 1986:143-152; Cf. Clark 1994:134-7). In the
latter instance, white farmers and mine owners solicited and received the
assistance of the government in disenfranchising blacks as a way of creating a
low wage labor force that would increase the profitability of both industries. The
basic strategy employed by the government to disenfranchise blacks was to first
alienate them from their land by implementing the 1913 Land Act which ended
the system of squatting and sharecropping by Africans on white farms, and the
1936 Native Trust and Land Act which reserved 86% of the total land area of
the country for whites only.
The combined effect of these two pieces of
legislation is that Africans were confined to residing on 14% of the land, most of
which was unsuitable for farming and grazing. This effectively destroyed the
formally viable and flourishing black peasant farming sector. Thereafter, '
taxes' and '
labor taxes'on blacks in the '
homelands' were imposed which
heavily taxed blacks earning a living in black areas ('
) with the intent
of compelling them to work for cash wages in '
white'areas while residing in
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black areas (Nattrass cited in Lowenberg and Kaempfer 2001:33-35; Cf. Lipton
and Simkins 1993:359-60).
From whence the Afrikaners gained political power, South African governments
have used all means at their disposal to further the lot of the Afrikaner
population in general and more specifically to solve the "poor whites problem"
(Omer-Cooper 1987:171-2; Cf. Clark 1994:48,163). An in-exhaustive list of the
tools used to achieve these goals includes '
import substitution industrialization'
(ISI), the creation of state owned enterprises, and last but not least - apartheid.
Thus, since the earlier stages of development and industrialization, the
Government extensively intervened in private markets on the side of white
1994:48,163; Cf. Lipton and Simkins (eds.) 1993:359-60; Cf. Lowenberg and
Kaempfer 2001:32-5).
There was also a conscious effort on the part of
Government to reduce or even eliminate '
dependence'on foreign trade which
had intermittently been interrupted by politically motivated trade embargoes
since as early as the 1940s (Lowenberg and Kaempfer 2001:6). The pattern of
exploitation of the African masses by the government in the name of
development and advancement was to continue up until the complete
dismantling of apartheid corresponding with the promulgation of the 1993
interim constitution.
In the light of the foregoing discussion, it can be reasonably ascertained that it
is virtually impossible to avoid the use of racial and ethnic categories and
divisions in chronicling any significant aspect of southern African history since
the use of such categories were inherently present in and have been key
determinants of the region’s past (Maylam 1986:136).
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Standard Industrial Classification (SIC) is a universal categorization that lists
primary industries to include – agriculture (SIC division A), mining (SIC division
B), and manufacturing (SIC division D) and secondary industries to consist of banking, real estate, and other services sectors. For the sake of keeping the
study within a reasonable scope and breadth of exploration, only the most
strategic and important (in terms of contribution to GDP) economic sectors will
be addressed in this chapter.
Thus, in the sections to follow the historical
development of the agricultural, mining, and manufacturing sectors will be
explored in seriatim.
3.2.1 Agricultural investment and development
The primary directive of any Government policy is to reflect the values and
norms of society.
Any change in these values and norms necessitates a
continued process of policy evaluation.
As part of the policy evaluation
process, existing as well as prior legislation, programs and policies must be
reviewed with the expectation of contributing to the contextual background that
informs the policy making process (White Paper on Agriculture 1995:16). This
is the approach followed here in reviewing investment and development in the
agricultural, mining and manufacturing sectors.
Indigenous Agriculture
Historically, agricultural production (of a very limited nature) can be traced back
to the first identifiable tribal inhabitants of South Africa.
There is strong
evidence suggesting that the Khoi-Khoi (named Hottentots by the Dutch) and
the San (called Bushmen by the Dutch) are the most ancient of inhabitants of
southern Africa whose cultural implements and way of life can be traced back to
University of Pretoria etd – Moeti, K B (2005)
the Late Stone Ages.
In addition to being hunter-gatherers, the Khoi-Khoi
engaged in livestock farming of cattle and sheep for milk, meat and clothing
(Omer-Cooper 1987:3-5).
There is also ample archaeological evidence showing that the Iron Age in South
Africa began around the fourth and fifth centuries A.D. The Iron Age tribes of
southern Africa, who came to be referred to as Bantu and Nguni by European
settlers, are believed to have had their origins in central and east Africa. It is
these early African inhabitants who were the first South Africans to engage in
crop harvesting. In addition to growing crops the Bantu and Nguni were also
self-sufficient in smelting iron and other metals mainly for the production of
agricultural tools (Omer-Cooper 1987:8).
European Settlement and Agriculture
Prior to the discovery and large scale exploitation of minerals in Southern
Africa, the basis of economy and exchange was principally driven by
agriculture. The early exploitation of the South African landscape by foreign
interests was initially based on it'
s strategic location for European trade routes.
Thus, in 1652 the Dutch shipping party of van Riebeeck landed at what is now
known as Cape Town to develop a halfway station for shipping expeditions and
trade between Europe, India and the East Indies (Butts and Thomas 1986: 567). The trade related business interests of the Dutch precipitated their eventual
conquest and settlement of the region.
It was under the mandate of the Dutch East India Company that the Cape
Colony was established. As a halfway station for trade the exploitation of the
land by this time was of a very limited nature. The surface area of the colony
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was confined to the small peninsula on which Table Mountain stands.
According to the needs of the Company'
s traders, a small fort was built along
with a garden of adequate size to feed and refresh the Company'
s travelling
crews. Meat supplies were gained through barter with the Khoi Khoi peoples of
the surrounding areas (Omer-Cooper 1987:17-18).
As the needs of the Dutch East India Company continued to grow, an incessant
expansion into the southern African landscape began to take shape. Based on
the suggestion of Van Riebeeck, a decision was taken by Company officials to
establish small farms to be owned and operated by some of their employees as
a way of meeting the increasing demand of the halfway station for food,
refreshment and meat. This decision turned out to be the pivotal point upon
which the Dutch perception of southern Africa changed from that of a
convenient and efficient halfway station for trade to being viewed as an ideal
location for settlement (Omer-Cooper 1987:17-18).
By 1679 the Company had expanded its territorial hold well beyond the Cape
peninsula to include amongst its land possessions, Hottentots Holland, False
Bay, Saldanha Bay and the Tygerberg area. It was also around this time that
the Dutch population began to be integrated with latecomer settlers from other
parts of Europe, namely Germans and French and Belgian Huguenots. The
French and Belgian Huguenots initially sought refuge from religious persecution
in Holland before being commissioned off by the Dutch government in Holland
to settle in the Cape. These Huguenots possessed superior wine making skills
of which they applied towards incubating the highly lucrative Cape wine industry
(Omer-Cooper 1987:19-20). The new French, Belgian and German immigrants
were encouraged, and in some cases coerced, to adopt the language and
culture of the South African Dutch community.
This amalgam of European
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immigrants formed a strong cultural and nationalist bond discernibly referring to
themselves as Afrikaners or Boers (the Dutch word for – farmer) (Omer-Cooper
1987:21; Cf. Butts & Thomas 1986:57).
Modern Agricultural Policy (i)
Apartheid-era Agricultural policy and development
As a prerequisite to discussing the South African government’s agricultural
policies during the apartheid era, it is important to first ensure clarity and
develop a common understanding and consistent usage of the terms ‘apartheid’
and '
apartheid era'
With regard to the term '
, a concise definition that will be used
throughout this text, is that proposed by Khan (1989:5-6). Khan (1989) defines
apartheid as the uniquely South African system of “…legal, institutionalized
segregation by race in order to organize society by a racial-ethnic hierarchy at
every level”. In other words, segregation policies determined under apartheid
were the law and any actions taken by any person or institution to contravene
those policies were considered illegal. Further, apartheid was implemented to
effect segregation in every aspect of the social, political and economic lives of
the people.
With regard to defining the term '
apartheid era'
, the origins of and period of
operation of the apartheid system are specified as a continuum that covers
almost a hundred years from the promulgations of the original Constitution of
the Union of South Africa in 1910 to the first democratic (interim) Constitution of
the Republic of South Africa in 1993.
Correspondingly, Lowenberg and
University of Pretoria etd – Moeti, K B (2005)
Kaempfer (2001:32) define ‘apartheid” as a “vector of policies that can be varied
in intensity along a continuum…and [that is also] responsive to the relative
influences of interest groups that receive benefits or incurs costs associated
[with it]…”. It is commonly accepted among scholars of South African history
and economics that the apartheid system originated as a response on the part
of the white working class to the threat of black labor-market competition and
has also been used as a tool of white employers to secure land and draw cheap
agricultural and mine labor from the rural African sector (Lowenberg and
Kaempfer 2001:33).
s policy of regulating the agricultural sector along racial and class
lines, left in it'
s wake a negative legacy that has survived and persisted into the
present. This apartheid era legacy that has unavoidably been inherited by the
present democratic government is what has commonly been referred to as the
two agricultures'(Lipton and Simpkins (eds.) 1993:360). The ‘two agricultures’
is epitomized by the reality of two separate agricultural sectors, one for whites
and one for blacks. The white agricultural sector has been (and continues to
be) heavily subsidized by the government resulting in a highly competitive
large-scale capital intensive industry that produced the bulk of domestic as well
as export food supplies.
The black agricultural sector, on the other hand,
received no assistance from the government and remained small-scale, labor
intensive and produced mainly for subsistence rather than for markets
(domestic or foreign) (Lipton and Simpkins ed. 1993:360).
Rather, the
government during the apartheid era actually took measures to handicap the
black agricultural sector in order to further benefit the white agricultural sector.
This approach of the government is exemplified by the 1913 and 1936 Land
Acts which restricted black ownership and residence in South Africa to 14
percent of the total surface area of the country. Another significant piece of
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legislation that impeded black agricultural development was the 1970
Subdivision of Land Act, which disallowed black smallholder farming in ‘white’
areas. Throughout this era black farmers were also excluded from access to
financial, marketing and other facilities of the numerous agricultural boards that
serviced and assisted white farmers only (Lipton and Simkins (ed.) 1993:360).
The paradox of the ‘two agricultures’ is an area of agricultural policy that is only
now being addressed (South Africa - White Paper on Agriculture 1995; Cf.
South Africa Yearbook 1999:75).
At present the discrepancies in land
ownership and production are such that approximately 67,000 white farms
produce 95 percent of marketed production on 85 million hectares (ha); while
an estimated one million black farmers produce 5 percent of marketed
production on 16 million ha (South Africa Yearbook 1999:75).
As the costs of direct support (cheap loans, subsidies and tax breaks) and
indirect support (protection from imports, provision of research and extension,
favorable terms of trade with the urban sector) to the white agricultural sector
had risen exponentially since Union in 1910, it became increasingly clear to
government that a reassessment of the costs and benefits of the agricultural
system was needed (Lowenberg and Kaempfer 2001:194-96). The costs of
subsidizing the white agricultural sector appears to have outweighed the
benefits thereof, as is evidenced by the fact that agriculture’s contribution to
Gross Domestic Product (GDP) has been estimated to have declined from
almost 20 percent in 1951 to 6 percent in 1990
(Lipton and Simkins (ed.)
University of Pretoria etd – Moeti, K B (2005) (ii)
Post-Apartheid agricultural policy and development
The four major challenges that face the South African agricultural sector in this
the post-apartheid era are firstly, the social and economic imbalances brought
about by the existence of the ‘two agricultures’ as an inherited challenge to
democracy and development of the industry (Supra Sect. (i)); secondly,
the poor agricultural resource endowment of the country evidenced by the fact
that only 17 million out of 100 million ha of farmland are presently classified as
arable, and only 4 million of these are classified as ‘high potential arable land’.
The remaining 80 million ha of farmland suffers from poor soil content, low and
erratic rainfall, and soil erosion and degradation.
Thirdly, amongst the most important factors limiting agricultural production is
the availability of water (South Africa 1999:76). The country’s average annual
rainfall is only 502mm which is well below the world average of 857mm.
Further, over the last decade or so, severe droughts, floods, hail storms and
frosts have contributed to reduced agricultural production; and fourthly, the
industry has also been plagued by inefficiencies and a tendency towards
oversupply in maize, wheat, livestock, dairy, sugar and wine production as a
direct result of stringent regulation and subsidization.
The result of these
artificial market supports of the white farming sector has been the frequent
tendency towards the dislocation of supply and demand in its trading market.
Oversupply of the market is also partly attributable to unpredictable weather
conditions that necessitates that farmers should plan their production with the
expectation of natural losses due to bad weather, pests, plagues, and other
The implications to farmers of oversupply include increased
transportation and storage costs, unfavorable volume-to-price ratios and
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wastage due to the perishable nature of produce. (Lipton and Simkins
1993:359; Cf. Loxton 1993:216-220; Cf. South Africa Yearbook 1999:76,83).
Despite the above-mentioned challenges to the agricultural sector, South Africa
remains self-sufficient in virtually all major agricultural products and is normally
a net-exporter of food stocks. Also, despite the industry’s steadily declining
share of GDP(4.1 percent in 1998/99 as compared to 20 percent in the 1930s) it
remains of vital importance to the economy as a provider of essential domestic
consumer food requirements whilst also employing approximately one million
people in its various sectors (South Africa 1999:75-6). (ii) (a) Marketing
The Marketing of Agricultural Products Act, 1996 (Act 47 of 1996) is the main
impetus of the current efforts to reform the industry. The 1996 Act, under the
supervision of the National Agricultural Marketing Council, scheduled the
termination of all agricultural sector boards and schemes established in terms of
the 1986 Marketing Act. By the 5th of January 1998, all agricultural control
boards ceased to exist. In terms of the Act, certain limited statutory measures
may be introduced in support of the industry, such as statutory levies to finance
the research and information functions within a given sector (South Africa
1999:84). As of the closure of the agricultural boards, the key objectives of the
NAMC are to integrate disadvantaged and small-scale participants into the
mainstream of agriculture and to monitor the efficiency of the market,
intervening only to correct market imperfections and socially unacceptable
effects (South Africa 1999:84; White Paper on Agriculture 1995:9).
University of Pretoria etd – Moeti, K B (2005) (ii) (b) - credit and assistance
In line with it'
s new policy directive, the national Department of Agriculture
resolved to remove itself from direct involvement in agricultural credit delivery
by abolishing the Agricultural Credit Board (ACB) and the State Assisted
Production Loan Scheme through Financial Intermediaries.
The agricultural
industry must now seek assistance from the Land Bank and/or private financing
from banks, creditors, financial institutions and agricultural co-operatives (South
Africa Yearbook 1999:85).
3.2.2 Mining Investment and Development
3.2.2 (i)
The importance of mining – Strategic Minerals
Although the bulk of South Africa’s minerals are not used domestically but are
instead exported, it is by way of these exports that minerals affirm their
importance to South Africa both economically and politically. This has been
observed in at least two ways.
Firstly, mining exports have consistently been the major source of foreign
exchange earnings and the largest contributor to GDP, and secondly, many of
the minerals that South Africa produces for export are ‘strategic minerals’ for
which the majority of importing country’s have no alternative supplier,
insufficient local supplies and for which no mineral substitutes exist (Butts and
Thomas 1986:35; South Africa Yearbook 1999:101-6).
Strategic minerals are generally defined as “those minerals determined to be
essential to critical civilian and military needs in quantities not available from
University of Pretoria etd – Moeti, K B (2005)
domestic sources or secure foreign sources and for which no short term
substitutes are available.”
The extent to which this definition holds is a direct
factor of time. That is, minerals considered strategic at some point in time
would cease to be considered as such with the passage of time. The passage
of time may result in technological breakthroughs that provide acceptable
substitutes for a strategic mineral(s). Alternatively, the time factor may also
lead to new discoveries of strategic minerals in the importing countries or
elsewhere on the globe.
Such new discoveries would then compete with
exported strategic minerals from South Africa (one of the few producers of
minerals classified as strategic) (Butts and Thomas 1986:37-42).
Due to their absolute importance in strategic sectors of industrialized and
developing countries, the following minerals have been classified by the United
States and its allies as ‘strategic minerals’ – chromium, manganese, cobalt and
the platinum group metals (PGM).
Oil during the early 1970s was also
considered a strategic mineral as its production and export was controlled by
OPEC, and industrialized as well as developing countries had highly limited
alternative sources of oil. Thus, the result of the 1973 OPEC oil embargo was
to throw oil dependent countries of the world into a prolonged recession.
The European Union, United States and Japan are virtually 100 percent
dependent on strategic mineral exports from southern Africa and the former
Eastern Block nations.
Southern Africa and the former Soviet Union, in
combination, control 99 percent of the world’s chromium reserves, 98 percent of
PGM reserves, 89 percent of manganese reserves and over 60 percent of
cobalt reserves (Butts and Thomas 1986:37-42).
University of Pretoria etd – Moeti, K B (2005)
The above-mentioned minerals are categorized as strategic in respect of the
uses to which they are applied. Perhaps the most conventional as well as
important application for Chromium is it’s conversion to an alloy in the
metallurgical industry.
The addition of chrome to steel imparts hardness,
strength, oxidation, heat resistance and resistance to corrosion. The resulting
alloys are used in superalloys for the aerospace industry, containment vessels
for nuclear power plants, petroleum processing facilities, and in the defense
industries. In the defense industries, one of the more critical uses of chromium
is in the production of key components of jet turbines for military fighter jets.
Chromium is also extensively used in the production of stainless steel, which by
definition contains between 10 and 18 percent chromium. The United States is
an important importer of Chromium. In 1984, U.S. consumption of chromium
was approximately 466,000 tons, eighteen percent of which was provided by
recycled scrap; the balance was imported.
South Africa was the leading
chromium supplier to the United States and provided 55 percent of Chromium
demand in 1984, followed by Zimbabwe with 8 percent and the former Soviet
Union with 7 percent (Butts and Thomas 1986:37-42).
Manganese is an essential element in the production of steel as it serves as a
purifying agent which removes the impurities of oxygen and sulfur. There is no
known substitute for manganese in this function. The steel industry in the U.S.
produced 93 million tons of steel in 1984, worth over $2.6 billion and imported
740,000 tons of manganese. It should be duly noted that the loss of access to
manganese imports would make U.S. steel production impossible, given that 99
percent of it is imported. The major sources of manganese ore were South
Africa with 31 percent, Gabon with 29 percent, Australia with 17 percent, and
Brazil with 12 percent (Butts and Thomas 1986:37-42).
University of Pretoria etd – Moeti, K B (2005)
Cobalt is an essential alloying agent in the electrical and aerospace industries.
The superalloys which require cobalt cannot be made with substitutes and
constitute its most critical use. Each F-100 engine used on F-15 and F-16 U.S.
fighter jets requires 910 pounds of cobalt for its ability to withstand stress of up
to 20,000 psi and temperatures of 1,800 F. In 1984, the U.S. imported 95
percent of its cobalt. The leading import sources were Zaire with 37 percent,
Zambia with 12 percent and Canada with 10 percent. Substitution for cobalt in
superalloys cannot be accomplished without a loss of effectiveness and
ceramic substitutes will not be available fro some time (Butts and Thomas
The platinum group metals of platinum, palladium, iridium, osmium, rhodium
and ruthenium are used in a wide variety of domestic applications. The most
strategically important of which are in the petroleum refining, petrochemicals
and telecommunications industries. In 1984, 91 percent of the PGM consumed
in the United States was imported. The leading supplier of PGM to the United
States in 1984 was South Africa with 49 percent, followed by the United
Kingdom with 15 percent and the Soviet Union with 13 percent (Butts and
Thomas 1986:37-42).
3.2.2 (ii)
The Importance of Mining – Beneficiation
Beneficiation is generally defined as the upgrading of a primary ore to a stage
where the component or component products can be used in a manufacturing
process (South Africa’s Minerals Industry 1987 – DME 1987:3). In other words,
beneficiation refers to the conversion of a raw material (mineral ore) into a
finished good or a partially finished good (work in-process good).
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The importance of beneficiation relates to the fact that unprocessed goods are
normally priced at a fraction of the same goods in beneficiated form. Thus it
can be surmised that the export of unbeneficiated minerals represents a
substantial loss of value added production and thus employment opportunities,
foreign exchange earnings and also losses with respect to international terms of
trade (Loxton 1993:247).
Extensive exporting of unbeneficiated primary minerals has essentially become
a relic of the colonial era as it is seldom done presently (Rogerson in Taylor and
Thrift (eds.) 1982:182-3; Fine and Rustomjee 1996:78). The current trend in
many developing countries and South Africa, is to process minerals at least
partially, mainly through smelting to produce a concentrate of higher value
which is then either refined or, more often, shipped to refineries in more
developed economies (Fine and Rustomjee 1996:78; Cf. Loxton 1993:247).
For South Africa in 1987, most of the manganese, phosphate and iron ore
entered production processes and/or export markets in un-beneficiated form,
while most of the mined metallurgical chrome, copper and nickel were in
contrast beneficiated. During 1987, 96 percent of zinc metal production was
consumed locally and none exported (South Africa’s Minerals Industry 1987 –
DME 1987:3).
Indigenous Mining
Southern Africa has a long and protracted history of mining exploration and
exploitation. This history pre-dates, by several centuries, the landing of the Van
Reibeeck party on the Cape Coast in 1652.
In fact, evidence has been
unearthed (and radio carbon tested) that suggests that tin, gold, copper and
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iron were mined and processed in and around the northern and eastern
Transvaal and portions of Zimbabwe as far back as the prehistoric Early and
Late southern African Iron ages (circa 500 - 1400 AD). These Iron Age mining
sites are dispersed across the former Transvaal state with the largest
concentration of sites in the Soutpansberg, Waterberg, Rustenburg and
Middelburg districts (Maylam 1986:12). Further evidence of Iron-age mining in
southern Africa exists in the form of fragments of nickel-bearing bronze found
near Rooiberg which were similar in composition to the bronze metals of
Sumeria, thus suggesting that there were smelting sites in southern Africa that
pre-dated the Christian era. These ancient mineral discoveries have often been
used as a guidepost to contemporary mineral explorers to locate new mineral
deposits (Butts and Thomas 1986:98-9).
Mineral exploration and exploitation undertaken in southern Africa prior to the
landing of the Van Reibeeck party attests to the fact that this mining was done
by indigenous Africans whose descendants are the so-called '
Africans (Maylam 1986:13). Indigenous mining was carried out on a smallscale basis and with rudimentary tools and techniques, however, the largescale mining discoveries and technological advances of the latter part of the
19th century changed the course and pace of development, politics and war in
the southern African region up to the present (Butts and Thomas 1986:98-9).
Diamonds were discovered along the Orange River in 1867. This discovery
attracted a significant population rush to the area in the form of mining
professionals, semi-professionals and laborers.
A virtual diamond mining
industry developed to the extent that approximately $714 million in diamonds
were recovered during the 60 year period following the 1867 discovery. The
Orange River area for some time dominated South Africa'
s economic output
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and was considered the backbone of the South African economy (Butts and
Thomas 1986:99). The British attempted to seize the opportunity to capitalize
on the wealth potential of diamond mining by colonizing the area. The Boers
effectively withstood the challenge and the First Anglo-Boer War (1880-1881)
ended with a British defeat. However, in 1886, the world'
s richest gold field was
discovered in the Witwatersrand area of the Transvaal near what is now
This discovery resulted in a flood of English labor and capital to the area, thus
providing an economic incentive for a second British attempt at annexation.
This time Britain was successful but the second Anglo-Boer War (1899-1902)
left in its wake a deep-seated bitterness and resentment toward the British as a
result of war casualties and concentration camp abuses (Butts and Thomas
Apartheid-era Mining Industry Development
The modest beginnings of the mining industry through the iron age and beyond
experienced exponential growth after the discovery of diamonds in 1867 and
gold on the Witwatersrand in 1886. Expansion was further accelerated by the
opening up of the coalfields of the Transvaal and Natal, and the discovery of
deposits of other minerals, such as those of chromium, platinum, manganese,
uranium and many others, the development of which led to South Africa’s
positioning as the leading country in the supply of many of the world’s mineral
needs (South Africa’s Minerals Industry 1987 – DME 1987:1).
In the years immediately following the formation of the ‘Union of South Africa’ in
1910, government policy was to exploit to the fullest, the wealth potential of the
University of Pretoria etd – Moeti, K B (2005)
newly discovered mining deposits in and around Witwatersrand. The intention
was to support the development and wealth creation of the mining sector in
order that taxation of this wealth would contribute towards the development of
other sectors of the economy (Omer-Cooper 1987:101,127).
Among the
actions taken towards this objective are the provision of:
Rail links from Witwatersrand to the coast;
Basic infrastrutural support to the Witwatersrand area; and
Incentives and support for the development of an explosives/chemicals
industry to supply the mines with dynamite for blasting.
Despite claims by successive governments since 1910 that the mining industry
developed through the active pursuit of economic policies based on the
principles of free market enterprise, encompassing the dependence on the
forces of supply and demand with the absence of undue State intervention,
there exists evidence to the contrary (South Africa’s Minerals Industry 1987
DME 1987:1).
Since Union, a plethora of legislation has been enacted to
advance the mining industry and white labor, mostly at the expense of African
labor. In the mining industry, where labor costs comprised a significant share of
total production costs, there was pressure on the part of mine-owners to
displace expensive white workers with lower-wage blacks.
The Mines and
Works Act of 1911, and the Labor Regulation Act of 1911 are examples of
government legislation that effectively, though indirectly, kept total labor costs
down (by restricting black wages) for the mines whilst reserving skilled and
semiskilled jobs for whites (Lowenberg and Kaempfer 2001:35-7, Seidman and
Seidman 1977:37-9; Omer-Cooper 1987:158-9).
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A key role in the development of the mining industry was played by so called
‘mining finance houses’. As surface diamond deposits depleted, more capitalintensive and high technology methods were required to exploit deeper level
deposits. Diamond mining was thus transformed from an activity conducted by
large numbers of independent diggers to an activity dominated and controlled
by large scale capital intensive enterprises commonly known as mining finance
houses. The first such enterprise was De Beers, headed by Cecil Rhodes,
which proceeded to extensively buy out small claim holders to take advantage
of the required economies of scale that it possessed. The Kimberly Central
Company run by Barney Barnato, also began to buy up claims in direct
competition with De Beers. Kimberly Central eventually merged with De Beers.
The other major mining finance houses that invested in the mining industry
Johannesburg Consolidated Investments (Johnnies), Gold fields of South Africa
(GFSA, an associate of a British Company, Consolidated Gold Fields), and
Union Corporation, Ltd. Of the six major mining finance houses established
before 1920, three were founded by South African diamond magnates (Rand
Mines – Beit; GFSA-Rhodes; Jonnies-Barnato); two were controlled by German
banks; and one, Anglo American, was founded with South African, British and
American capital (Seidman and Seidman 1977:39-40; Cf. Omer-Cooper
Mining industry development undertaken by the major mining finance houses
was augmented to a considerable degree by government investment in mining
industry sectors which were considered to be of great importance to the
national interest but for which there existed insufficient investment interest in
the private sector. It was during the apartheid era that the government provided
financial assistance for the establishment of a national steel industry, ISCOR
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ltd. Later, through the industrial Development Corporation ltd. (IDC) it financed
the Phosphate Development Corporation ltd (FOSKOR) for the supply of
phosphate, SASOL which converts coal to oil, and ALUSAF for aluminum
SOEKOR (Pty) Ltd., formerly the Southern Oil Exploration
Corporation Ltd, is engaged in the search for oil and gas, both on land and
offshore, and is wholly financed by the Central Energy Fund (Lipton and
Simpkins 1993:131-3; South Africa’s Minerals Industry 1987 – DME 1987:3).
Modern Mining - Economy and Policy
Presently, South Africa'
s minerals industry is broad based in terms of the variety
of mineral commodities mined and traded. Over time, it has not only evolved
itself into being the cornerstone of the South African economy, it has also been
instrumental in providing surplus capital used to develop the country'
s economic
infrastructure while additionally serving as the outlet for and generator of
several sectors of the country'
s secondary industries (South Africa - DMEA
1987:1; WP Mining and Minerals Policy 1998:3; Fine and Rustomjee 1996:1223; Loxton 1993:248).
Secondary industries spawned by mining include
explosives, chemicals, and engineering and capital goods such as drill steels
and earthmoving equipment (Fine and Rustomjee 1996:72). (i)
Role of mining in the national economy
By 1987 government statistics indicate that just over a thousand mines and
quarries were in operation, producing 60 different minerals and exporting
mineral commodities to 83 countries. Mining’s contribution to Gross Domestic
Product (GDP) has averaged about 15% in recent years, while mining’s
contribution to Gross Domestic Fixed investment (GDFI) was estimated to be
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8.9% (or R7.8 billion) (South Africa’s Minerals Industry 1987 – DME 1987:1-4;
South Africa Yearbook 1999:97-8; Loxton 1993:247). Mineral exports account
for almost 40 percent of South Africa’s exports and this figure is significantly
increased when various processed mineral products such as the ferro-alloys
and steel are included.
The major importers of South African minerals are
North America, Europe and the Far East (South Africa’s Minerals Industry
Total employment in the mining industry has been estimated to be on the order
of 700,000 people by 1987. The largest sector within the mining industry is gold
mining which employs more than 70 percent of the minerals industry'
workforce and accounts for almost 35 percent of total World gold production.
Other major contributors to the mining industry'
s share of Gross Domestic
Product include platinum, diamond, uranium, iron, copper, manganese, chrome,
phosphate and asbestos, as well as several base minerals (South African
Minerals Industry 1987:1). (ii) (a)
Modern Mining Policy - Privatization
Although there have been several major shifts in government policy regarding
the privatization of the above-mentioned industries, the current policy of the
government is to privatize all state run enterprises (Fine and Rustomjee
1996:108;Lipton and Simpkins 1993:130-3). After more than 60 years of direct
state intervention and investment in industrialization through state owned
enterprises, official government policy articulated a need for change and
privatization (Lipton and Simkins ed. 1993:129-133).
The policy aims and
objectives set out in the 1987 White Paper on Privatization and Deregulation in
the Republic of South Africa and supported by then President Botha in his 1988
University of Pretoria etd – Moeti, K B (2005)
opening speech to parliament affirmed governments intent to privatize (Lipton
and Simkins ed. 1993:129-133). ISCOR was the first major state enterprise to
be privatized in 1989 and the process continues to this day although under the
strain of a strong and vocal anti-privatization movement. (b)
Modern Mining Policy - Mining Rights
Mineral rights constitute rights in the land. They are officially registered by the
State, and are a form of property protected under the Constitution. Mineral
rights are also tradeable (White Paper – Mining and Minerals Policy for South
Africa 1998:11).
The government, under the leadership of the Minister of Minerals and Energy
Affairs seeks to reform the current system of South African mineral rights that
has developed over many years into a ‘dual system’ of prospecting and mining
rights. Mining policy is termed '
dual system'in the sense that mineral rights
may be vested in either private or public ownership (White Paper – Mining and
Minerals Policy for South Africa:11).
This dual system of mineral rights has it’s origins in common law under which
ownership of the land includes ownership of the minerals in the land. The law
developed in such a way that the right to minerals in respect of land can be
separated from the title to the land, for example upon original grant of the land
or by subsequent transactions. The owner of land from which mineral rights
have not been separated may separate the mineral rights from land ownership
by ceding them to another person or by reserving them to himself or herself.
The mineral rights are then held under separate title which may include all the
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minerals in the land concerned or only a particular mineral or minerals (White
Paper – Mining and Minerals Policy for South Africa:11).
South Africa and the United States of America are two of the few major mining
countries that have a dual system of public and private ownership of mineral
rights. In most other countries the right to minerals is vested in the State (White
Paper - Mining and Minerals Policy for South Africa 1998:13-17). The South
African government'
s intent, however, is to do away with the dual system in
favor of State ownership of all mining and prospecting rights. This policy is
motivated by the government'
s desire to enable citizens to gain access to rights
in land on an equitable basis and is motivated firstly, by Constitutional
provisions empowering government to execute reforms to redress the results of
past racial discrimination, and secondly by article 2(1) of the UN Charter of
Economic Rights and Duties of the State that grants to States full permanent
sovereignty, including possession and disposal, over all its natural resources. In
summary, Government’s long term objective is for all mineral rights to vest in
the State for the benefit of and on behalf of all the people of South Africa (White
Paper - Mining and Minerals Policy for South Africa 1998:13-17).
Despite the above restructuring of mining and prospecting policy, the South
African government intends to maintain the following key objectives thereof,
namely to (White Paper – Mining and Minerals Policy for South Africa 1998:1317):
Promote exploration and investment leading to increased mining
output and employment;
Ensure security of tenure in respect of prospecting and mining
University of Pretoria etd – Moeti, K B (2005)
Prevent hoarding of mineral rights and sterilization of mineral
Address past racial inequities by ensuring that those previously
excluded form participating in the mining industry gain access to
mineral resources or benefit from the exploitation thereof;
Recognize the State as custodian of the nation’s mineral
resources for the benefit of all;
Take reasonable legislative and other measures, to foster
conditions conducive to mining which will enable entrepreneurs to
gain access to mineral resources on an equitable basis; and
Bring about changes in the current system of mineral rights
ownership with as little disruption to the mining industry as
The government’s policy proposals have met with extensive stakeholder
reservations. Among the contentions raised against a transfer of mineral rights
to the State are that (White Paper – Mining and Minerals Policy for South Africa:
a. The blanket transfer of mineral rights to the State could easily lead
to administrative difficulties in a system not geared to the
management of mineral rights, extensive delays and hence a loss
of investor confidence that could seriously damage the South
African mining industry;
b. Holding of mineral rights is a critical parameter in the valuation of
a mining company by international investors.
The company is
valued according to its future potential which depends on an
ongoing flow of new projects derived from such mineral holdings;
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Private ownership of mineral rights based in the law of property is
preferable to a pure licensing system of rights based in
administrative law and involving administrative discretion. Private
ownership affords the absolute long-term security of tenure that
attracts investment in exploration, mining and marketing; and
d. A bias towards state ownership would run counter to the
Government’s philosophy and policy on competition and
Government policy with regard to the aforementioned is still in the preliminary
stages and is currently expressed solely in the form of a discussion document.
As there is a vast amount of stakeholder input into the legislative process, the
final version of the new legislation is expected to be modified into a much more
moderate version than expressed in the discussion document.
Manufacturing Investment and Development
The First and Second World Wars comprised the catalytic force(s) that
launched the country into its second industrial revolution, transforming it from a
mining economy to a predominantly manufacturing one (Omer-Cooper
1987:182-3). Metals and engineering were the major nodal growth points of
war production to the extent that before the war, almost all mining and industrial
machinery was imported while the South African engineering industry was
mainly occupied in service and maintenance work. As a direct result of wars, it
was no longer possible to import the industrial machinery required for local
production of consumer and industrial goods. Yet, the South African metals
and engineering industries responded to the challenge. By the end of the war
South African manufacturing industry was not only capable of mass
University of Pretoria etd – Moeti, K B (2005)
manufacture of a wide range of consumer goods but was also developing the
capacity to manufacture the machines with which these goods could be
produced. Though still needing technological imports, South African industry
had passed the vital point of take-off into self-sustaining growth (Omer-Cooper
1987:182-3: Cf. Clark 1994:107).
After the Second World War, manufacturing development was further spurred
by the fact that modern manufacturing technology required vast amounts of
capital as well as large markets capable of absorbing its output.
It was
recognized by the government of the time that these dynamic requirements of
manufacturing development could only be achieved through state intervention
and support by the private sector. In this regard, the government thus engaged
the following strategy (Seidman and Seidman 1977:56-58):
Provided the capital and technological needs of some of the ‘critical
basic’ industries in close cooperation with domestic and foreign firms;
Intervened to provide favorable treatment to the import of capital goods
and raw materials needed in manufacturing;
Banned certain consumption goods regarded as non-essential (such as
foodstuffs, clothing and luxury items) thereby providing a stimulus to the
local production of them, as well as saving foreign exchange; and
establishment of parastatals (public corporations).
The most controversial and perhaps the most effective of the above-mentioned
industrialization strategies of the government was the direct investment in
parastatals. By the 1970s, government’s contribution to gross domestic fixed
University of Pretoria etd – Moeti, K B (2005)
investment (GDFI) amounted to almost half of all investment (public and
private) in the entire economy (Seidman and Seidman 1977:59-67).
One of the major parastatals involved in the process of manufacturing
industrialization is the IDC. Founded in 1940, the IDC played a supporting and
lubricating role for infant industries that in turn made their contribution to
industrialization. The mission of the IDC at its inception was to ‘to facilitate,
promote, guide and assist in the financing of new industries and industrial
undertakings and schemes for the expansion, better organization and
modernization of, and the more efficient carrying out of, operations in existing
industries and industrial undertakings’ (IDC 1971 – cited in Seidman and
Seidman 1977:64; Cf. Fine and Rustomjee 1996:159).
Largely through the
financial and technical assistance of the IDC, by the early 1970s ISCOR (Iron
and Steel Corporation) was producing almost 75 percent of all steel consumed
in South Africa, while ESKOM (Electricity and Supply Commission) was
supplying about four fifths of the country’s electricity, and SASOL produced 12
percent of the country’s oil needs (Seidman and Seidman 1977:59-67).
More than 60 years after the establishment of the first parastatals, the
government had recorded a high level of success towards industrialization
through the development of a well-tooled manufacturing sector (Loxton
1993259-260; Cf. Clark 1994:165). However, the era of the late 1980s ushered
in new government thinking on the continued viability of the parastatals. The
government planned to privatize all parastatals in the face of numerous
economic, political and social challenges during the decade of the 1980s, these
challenges included the following (Clark1994:165-169; Cf. Lowenberg and
Kaempfer 2001:209-212):
University of Pretoria etd – Moeti, K B (2005)
The gold price dropped from $613 an ounce in 1980 to $359 by
Foreign loans amounting to $14billion had been withdrawn by
international lenders;
Sanctions had been implemented by the United States and the
European Economic Community;
The rand had depreciated to a low of 37 U.S. cents;
Internal unrest prompted the government to enact a state of
emergency for more than five years; and
The evolving cost structure of the parastatals showed that they
were using greater amounts of state resources and becoming
less profitable.
Although it has been argued by some that the government’s call for privatization
was an attempt to transfer vast state resources into the exclusively white private
sector before turning power over to a black government, it is more likely that the
Botha administration succumbed to the abovementioned environmental
pressures and sought to partially redress them by obtaining sufficient capital
through the sale of state firms (Clark 1994:166).
The reduction of direct government involvement in the economy has been a
gradual process that actually began in the 1960s. After 1960, the government
established no new state enterprises and instead turned the focus of the IDC to
supporting private initiative through such programs as the Export Finance
Scheme (1960) to subsidized South African exports, the Border Areas
“homelands,” and efforts at “rationalization” that merged firms in the same
industry under IDC-sponsored holding companies (Clark 1994:166).
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Outward-Oriented Industrial Policy
Up until 1992, the two key institutions in formulating and implementing industrial
policy were the Industrial Development Cooperation (IDC) and the Board of
Trade and Industries (BTI) (Fine and Rustomjee 1994:14,179). While the role
of the IDC was to move the country towards industrialization through the
establishment and support of state-owned industries, the BTI was tasked with
improving industrial performance through the administration of tariff policies
(Fine and Rostomjee 1994:14, 179). However, tariff protection proved to be an
ineffective form of industrial support as indicated by several commissioned
reports that led to the emasculation of the BTI by the BTI Amendment Act of
1992 (Fine and Rostomjee 1994:14, 179).
While the Viljoen Commission Report of 1958 supported the use of import
tariffs, the Reynders Commission report of 1972 emphasized the need to shift
industrialization policy to be outward orientated, and thus the need to reduce
import tariffs.
Following some of the recommendations of the Reynders
Commission, the IDC in 1990 reversed industrial policy in South Africa through
a double-pronged strategy which consisted of first reducing import tariffs, the
basis of BTI’s discretionary power, and secondly, supporting export-oriented
capital investment through tax incentives (Fine and Rustomjee 1994:200). As a
result of the implementation of the IDC’s revised industrial policies, the BTI lost
its prominence as a key institution in industrial policy formulation and was
restructured and renamed the Trade and Industry Advisory Board in 1992 which
is now tasked with advising the Trade and Industry minister on tariffs and
dumping duties (Fine and Rustomjee 1994:202).
University of Pretoria etd – Moeti, K B (2005)
Disinvestment, Trade Sanctions and the Economy
Apartheid, as previously defined (see above), was simultaneously a
social, political, legal and economic phenomenon that underscored every
aspect of South African societal life.
The economics of apartheid has
traditionally been studied under either of two divergent and polemic approaches
known as the liberal approach and the neo-Marxist approach.
The ‘liberal’ approach saw apartheid as inherently anti-capitalist in that it
interfered with the free movement of supply and demand forces in the economy
by protecting white workers from labor-market competition with blacks.
contrast, the neo-Marxist approach viewed apartheid as a uniquely South
African form of capitalism, in which apartheid laws served to enhance the
productive capacity of the economy by ensuring an elastic supply of black
workers at low wage rates (Fine and Rustomjee 1996:21-2; Lowenberg and
Kaempfer 2001:1).
Although the distance between these two positions is enormous both in
methodology and in conclusion, the international consensus on the efficacy of
apartheid encompassed not only it’s economic viability, but also examined it’s
social, political and ethical ramifications in calling for the dismantling of the
International trade sanctions and disinvestment campaigns instituted against
South Africa in the mid to late 80s were intended to serve as the means through
which the apartheid system would be brought to an end.
In this regard,
apartheid was seen as a system that could not be changed other than through
indirect means. Thus, international measures taken to negatively affect the
University of Pretoria etd – Moeti, K B (2005)
South African economy were expected to lead to internal pressures (especially
from the politically influential business sector) for a dismantling of the system.
Disinvestment, in the present context, is defined as the sale of physical or
financial assets in a target country by individuals or governments of foreign
nations (Lowenberg and Kaempfer 2001:122).
As such, it can readily be
ascertained that the intended outcome (on the part of those disinvesting) of
disinvestments is to deny the target country access to the physical, financial, or
human capital of foreign individuals or foreign-owned multinational firms
(Lowenberg and Kaempfer 2001:122).
Economic sanctions, on the hand, refer to import and/or export trade restrictions
imposed by sanctioning governments against a specific target country. The
intent of sanctions is to bring about policy change in the target country through
imposing, or sometimes merely threatening, the severest possible economic
The expectation is that the target country will comply by altering its
objectionable behavior/policy as long as the cost of doing so is less than the
costs brought about by the sanctions (Lowenberg and Kaempfer 2001:80; Cf.
Khan 1989:23).
There are several constraints that may impede the effective functioning of
sanctions and disinvestment against a target country. A key constraint being
that legislated disinvestment often leads to the sale (at bargain basement
prices) of fixed assets (plant, equipment and land) of multinational firms of
disinvesting countries to domestic firms or multinational firms from countries
that are not participating in the disinvestment campaign. The takeover of the
assets of disinvesting firms in this manner will result in a continuation of the
economic activities under question as well as a continuation of the offending
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target state policies. A similar problem exists with the use of trade sanctions in
that the economic impacts of the sanctions can be circumvented with relative
ease by target countries, by simply channeling their imports and exports to
alternative trading partners.
Thus in order for disinvestment campaigns and trade sanctions to have any
economic effect in the target country, there must be a concerted and
coordinated international effort that involves the participation of as many
countries as possible.
In the case of the 1986 South Africa sanctions, the
sanctioning countries usually chose to boycott those imports that comprised a
non-critical share of South Africa’s total exports of the good in question (e.g.,
US and Canadian coal and agricultural sanctions). In other instances where the
sanctioning countries were highly dependent on the import of a particular good
from South Africa, South Africa’s level of trade with the sanctioning countries
was generally small relative to world trade, suggesting a highly elastic demand
by the rest of the world and readily available substitute markets (this was the
case with OECD iron and steel sanctions). Alternatively, in some instances,
sanctioning countries imported a large share of South Africa’s total exports of a
particular good, but the importance of those exports to South Africa (in terms of
their share in total South African exports of all goods) was small (e.g., US
sanctions on South African apparel). In all of the above-cited cases the level of
economic damage to South Africa was minimal (Lowenberg and Kaempfer
2001:111-19) (Cf. Tables 3.1, 3.2 and 3.3 below).
Although economic sanctions and arms embargoes had been launched against
South Africa as far back as 1940, it was only by the late 1980s that
comprehensive and coordinated international sanctions and disinvestment
campaigns became sufficiently encompassing to have a major impact on the
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South African economy (Lowenberg and Kaempfer 2001:6). In terms of United
States statistics, seven U.S. firms ended their direct investment in South Africa
in 1984, and forty in 1985, with the trend peaking at fifty-seven in 1987 (Khan
1989:61-5). Khan (1989:41) estimated the total output multiplier for the South
African economy in the mid 70s to be on the order of four. Meaning that a
sanctions induced decline in total exports of $1million would have resulted in a
decline in output (GDP) of about $4million.
The sanctions multiplier
disaggregated for the key economic sectors amounted to 1.176 for agriculture,
1.0006 for gold, 1.025 for mining, and 1.377 for food, with all of these sectors
expected to indirectly affect many others.
University of Pretoria etd – Moeti, K B (2005)
Table 3.1
Major Trade Sanctions against South Africa, 1986
United States
Steel and iron, coal,
textiles, agricultural
Computers to apartheid-
goods, uranium,
enforcing agencies
United Kingdom
Steel and iron,
"Sensitive" equipment to
police and army
European Community
Steel and iron
"Sensitive" equipment to
police and army
Canada (and the
Steel and iron, coal,
agricultural goods,
uranium, Krugerrands
Steel and iron,
Computers to apartheid-
enforcing agencies
Source: Congressional Quarterly, September 1986, p.2271
Adapted from Khan 1989, p.54
University of Pretoria etd – Moeti, K B (2005)
Table 3.2
South Africa'
s Major Exports and Imports in 1986 (US$ in millions)
Non-electric machinery
Transport equipment
Electrical machinery
Chemical elements and compounds
Instruments, watches, and clocks
Miscellaneous manufactured goods
Plastic materials
Chemical products
Metal manufactured goods
Iron and steel
Non-ferrous metals
Coal, coke, briquettes
Iron and steel
Metalliferous ores
Non-metal mineral manufactures
Fruits and vegetables
Chemical elements and compounds
Crude fertilizer and minerals
Textile fibers
Sugar and preparations of honey
Source: U.S. General Accounting Office, South Africa. Trends in Trade,
Lending, and Investment, Report to Congressional Requesters (April 1988 p.
Adapted from Khan 1989, p. 54
University of Pretoria etd – Moeti, K B (2005)
University of Pretoria etd – Moeti, K B (2005)
The current chapter sought to explore the investment climate faced by
multinational firms in South Africa largely from a historical perspective. This
was done in order to define and clarify the context within which foreign direct
investment policy has taken place in South Africa in the past, with the
expectation that this historical context has relevant implications for resolving
present and future foreign direct investment policy issues. Thus, the central
underlying assumption of this chapter is that a cursory exploration of what went
before is required to understand and critique what currently exists.
Agriculture, mining and manufacturing are the three largest sectors of the South
African economy in terms of contribution to gross domestic product and are
thus considered the most relevant in terms of defining the contextual economic
environment within which foreign and domestic investment takes place. The
deterministic element that runs through every aspect of development and
investment in South Africa’s recent past is the system of racial discrimination
and segregation known as apartheid. Apartheid policy affected not only South
Africa’s domestic productivity but also affected it’s international trade and
investment as the international community began to act to undermine it. In the
final analysis, the system of apartheid brought itself to an end as, with the
passage of time, it increasingly proved itself to be an unworkable political, social
and economic system. Although apartheid no longer exists, it has left behind a
significant legacy that represents hindrances in many sectors of the economy
that are only presently being resolved.
In this chapter, each of the above-
mentioned economic sectors (agriculture, mining and manufacturing) was
University of Pretoria etd – Moeti, K B (2005)
assessed in seriatim in order to derive an indication of the attractiveness of the
investment environment to foreign investment.
The agricultural sector of the economy has shifted from first to third place in
terms of share of GDP in contemporary times.
Although this sector of the
economy continues to be plagued by climatic and natural resource
encumbrances, it’s contribution to GDP and thus development is significant as it
employs over a million people and exports the majority of its produce. The
apartheid legacy inherited by the agricultural sector is what has come to be
called the two agricultures. As apartheid was an expensive system to maintain,
there appears to be evidence that the productivity of agriculture was reduced as
a direct result of the costs of subsidizing the white farming sector while
disenfranchising small-scale black farming.
The mining sector of the economy is credited with moving the country into its
so-called second industrial revolution.
This sector of the economy is
characterized by a concentration of capital ownership among the formally six
mining finance houses. Mining also received substantial state support through
legislation that provided for cheap African labor. South African mining grew to
be important not only to the domestic economy, but also served the strategic
minerals needs of much of the advanced industrialized countries. At present,
new mining legislation has been promulgated to address the government’s
concerns about big business exploitation of the long-standing prospecting and
mining rights laws, as well as the racial incongruencies of the past.
Manufacturing development and investment grew largely out of the concern of
the government to diversify out of the predominantly mining and agricultural
based economy. The government’s approach was initially to financially support
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manufacturing through the extensive taxation of mining. However, government
policy later turned to the establishment of public enterprises to (directly and
through support of private industry) provide the inputs needed to stimulate and
support manufacturing.
The defining period of South Africa’s economic history was the crisis brought
about by the trade sanctions and disinvestment campaigns against her in the
mid to late 1980s. Although these measures were initially ineffective in meeting
their objectives of bringing an end to apartheid through the creation of negative
economic outcomes in South Africa, the broadening and improved consensus
and coordination among sanctioning and disinvesting countries of the world
closed up the gap that caused the initial ineffectiveness in the system.
Although an extensive amount of foreign investment was lost to the
disinvestment movement, the extent and pace at which foreign investment has
returned to South Africa in the post-apartheid era is a defining issue in
determining the Government’s policy approach to foreign investment. In this
regard, a balance must be found between too liberal an approach that may
allow for abuses of the state by multinational enterprises, and too restrictive a
stance that may tend to stem the flow of much needed inward investment.
University of Pretoria etd – Moeti, K B (2005)
Chapter 4
Global Foundations for Establishing a Need for the Regulation
of MNEs
Currently in the Republic of South Africa (RSA) there is no governmental body
at any level of government that is charged with complete/centralized
responsibility for policy-making and regulation of foreign direct investments
(FDI) in the form of multinational enterprises (MNEs).
Other advanced
industrialized countries have long been convinced of the need to regulate this
type of investment through such government agencies as the Foreign
Investment Review Agency (FIRA) in Canada and the Committee on Foreign
Investment in the United States (CFIUS).
In this age of regional trading blocks forming across the globe, countries with
the wealth of resources as exists in South Africa need to address trade and
investment issues that go beyond simply attracting increasingly greater
amounts of foreign investment. That is, although big business has much to
contribute towards global economic advancement, unregulated big business is
subject to engage in a number of social, legal and economic abuses least of
which is the distortion of markets through market domination and the erection of
barriers to competition.
As case in point, a substantial proportion of the
organizations that are in a position to operate monopolistically or as oligopolists
also tend to operate internationally as multinational enterprises. The size and
scope of foreign direct investment activity in South Africa is significant enough
University of Pretoria etd – Moeti, K B (2005)
to warrant concern and closer examination of government policy and
administration applicable to these businesses.
A discussion of foreign direct investment and multinational enterprise policy
from a public administration perspective, necessitates at the very least a basic
understanding of the empirical as well as the theoretical debates on this type of
Thus case studies as well as theory are looked upon in this
chapter for guidance in addressing the possible legal, political, administrative,
social and economic (among other) perplexities posed by this type of
investment in South Africa.
The overarching goal of the current chapter is to explore the following research
question – i.e., is there a need for multinational enterprise policy for South
Africa? Although the next chapter (chapter 5) addresses this question to some
extent, it does so from a markedly different perspective than that proposed in
this chapter. In chapter 5 the objective is to resolve this question by surveying
and evaluating those policies that are currently in place within the existing
decentralized arrangement and assessing the level of adequacy of said
In contrast to the approach of chapter 5, the current chapter takes a much
broader and comparative approach to resolving the above-mentioned research
question. The current chapter will look outside of South Africa for answers to
this question. The approach is to analyze events from a number of countries or
regions in order to gain a contextual setting against which South African foreign
direct investment policy and regulation (or the approbation thereof) can be
evaluated. The chapter then narrows its focus to address this fundamental
question within the local context through case study examination in order to
highlight the appropriateness and need for policy regulating multinational
enterprises in South Africa.
University of Pretoria etd – Moeti, K B (2005)
International Perspective on the Justification for MNE regulation
In the process of determining the adequacy of existing foreign direct investment
and multinational enterprise policies, and in order to assess the organizational
soundness of government structures that exist to implement these policies, it is
necessary to first define the terms policy and regulation. A comprehensive
definition of policy is given in chapter 5 (Supra Sect. 5.2) and will thus not be
duplicated here.
Exploring the universal bases upon which foreign direct investment and
multinational enterprise policies stand, begs the question of why this type of
investment should be regulated. Regulation is defined in the New MerriamWebster dictionary as the act, or state, of being regulated; and alternatively as a
rule dealing with details of procedure and having the force of law (The New
Merriam-Webster dictionary). Regulation derives much of its meaning from its
root word regulate, and regulate in turn is defined as the act of fixing or
adjusting the time, amount, degree, or rate of (The New Merriam-Webster
In discussing the regulation of multinational enterprises, it is
instructive to associate the meaning of the term regulation with the
aforementioned definitions as opposed to yet another definition that equates
regulation to control.
The term control suggests rather radical or extreme
connotations, and is more aptly used in the context of the power to restrain or
direct, which go beyond what is relevant to the discussion that follows.
Amongst the international community of nations a number of motivations have
been posited for the essentiality of regulating foreign direct investment at the
national, regional and international levels. Most of these rationales regress
University of Pretoria etd – Moeti, K B (2005)
upon the vast magnitude of the resources controlled by these enterprises and
the resultant economic, social and political power that this wealth infers.
These regulatory policy motivations and actions are best explored from an
historical perspective in order to understand the evolvement of foreign direct
investment policy to its current ideological state and the environmental factors
(social, political or economic) that may have contributed to or influenced these
policy positions.
One approach to studying this dynamic of the interplay between cause and
effect is the systems approach (Parsons 1995:23-5). The systems approach to
problem solving provides an organized way of separating institutions and
organizations from their environment(s) thus bringing all pertinent relationships
into sharper focus. For the case in question, multinational enterprises posses
or stand to gain some power (social, political and economic) over their
environment – the host country; whilst at the same time, the host
country/environment exercises some power (or control) over multinational
enterprises through regulation in order to limit the perceived social, political and
economic power they may obtain.
This set of relationships defines the
fundamental and overarching framework within which the foreign direct
investment and multinational enterprise policy process takes place and evolves
over time (1974 United Nations Report in Modelski 1979:319-20; Cf. Parsons
4.2.1 Stages of evolvement of multinational enterprises
Within the context of the systems approach, the need to regulate multinational
enterprises is related to the significance given to this type of investment by
government administrators and policy makers. In this regard, accepting that
multinational enterprises are an important derivative of the world economy, it is
instructive to note that at different times throughout history, multinational
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enterprises have occupied a greater or lesser place in the field of international
trade regulations. At times, concern vis-à-vis controlling the possible abuses of
multinational enterprises was prevalent among policy makers and at other times
the issue proved to be insipid. These variations in interest over the activities of
multinational enterprises can be explained by taking account of Makler’s (1982)
stages of development of the world economy, in addition to Taylor and Thrifts
(1982) description of the development of international capitalism, and
Muchlinski’s (1995) evolutionary phases of modern multinational enterprises.
Makler (1982:5-12) offers a stageist approach to analyzing the vicissitudes of
these dynamics and argues that the world economy (and by default,
multinational enterprises) developed through subtle yet clearly distinguishable
transitional phases (Cf. Taylor and Thrift 1982:277-284; Cf. Muchlinski 1995:19-
33). These phases being:
(a) The shift from feudalism to capitalism;
(b) The stage of competitive capitalism;
(c) The stage of imperialism; and
(d) The stage of transnational capitalism.
The importance of these theoretical phases lies in their specification of the
relational values that underlie them.
Thus, the relational properties of
integration and conflict among firms, markets and states can be discerned in
each phase along with the policy responses thereof. Following Makler’s (1982)
reasoning, it can further be ascertained that foreign direct investments by
multinational enterprises are a contemporary phenomenon for which policy
stances have understandably been erratic. This political erraticism emanates in
part from the lack of empirical work on the effects of inward foreign direct
investment and multinational enterprises. The stages of development through
which multinational enterprises have evolved are briefly discussed hereunder.
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The stage of transition from feudalism to capitalism
The first of Makler’s (1982) phases is marked by a transition from feudal
economic systems to capitalism and thus covers the period leading up to and
including the Industrial Revolution circa the sixteenth century to the early
nineteenth century.
This period of world economic development was
characterized by the accelerated propagation of international trade that was
underpinned by the evolvement of distinctive cultural, legal and socio-structural
arrangements that proved conducive for the implementation of capitalist
economies and societies. Thus, development during this phase was spurred on
by; firstly, the freeing of labor from feudal restrictions; secondly, the
accumulation of merchant and financial capital; and lastly the growth of
international markets.
The industrial revolution also brought about a new mode of trade between
industrializing/developing countries (center) and underdeveloped countries
The nature of this mode of trade was such that industrializing
countries had the industrial capacity to concentrate on the production of fully
manufactured and luxury goods, for which trade in raw material inputs from
underdeveloped countries was essential. Thus began the development of what
has since come to be known as the unequal exchange mode of trade between
center and periphery countries. The accumulation of surplus capital and the
formation of monopolies also resulted from the industrial revolution, which in
turn represented the necessary conditions for the development of globally
oriented multinational enterprises that could engage in both export trade as well
as in foreign direct investment (Taylor and Thrift 1982:279-281).
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The stage of competitive capitalism
The second of Makler’s (1982) stages, competitive capitalism, was prevalent
throughout the nineteenth century. Although this stage is characterized by a
general acceptance of free-market systems and political sovereignty by the
majority of the world’s nation-states, there was also a simultaneous and robust
ideological shift towards an interdependent world economy dominated by the
then colonial superpower, Britain. As the first of the world’s nation-states to
become truly industrialized by the middle of the nineteenth century, Great
Britain was able to manipulate the world economy in favor of British capital
supported by British military power and geo-political colonial policies (Makler
The stage of imperialism
Makler’s (1982) third phase, imperialism, extends from the turbulent period of
the world economic crisis of 1873-96 to the Second World War. The defining
characteristic of this phase was the conquest and colonization of nonindustrialized nations by the established industrialized powers of the time.
During this phase, however, the rate of growth of foreign direct investment by
multinational enterprises declined steadily as a result of global political and
economic instability.
Thus in this period, the Bolshevik Revolution which
brought communism to the Soviet Union cut off trade and investment to a
sizable participant of the then global economy. Almost simultaneously (circa
late 1920s to early 1930s), the collapse of global capital markets led to the
great depression during this period, which also contributed to the slow down in
international investment. Lastly, the fear of the outbreak of a Second World
War was yet another factor that soured the global investment climate by
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precipitating nationalistic economic policies characterized especially by the
erection of high tariff barriers to trade (Muchlinski 1995:22-3).
Transnational capitalism
The last of Makler’s (1982) phases, transnational capitalism, resulted as an
aftermath of the Second World War. Whilst the Second World War precipitated
the collapse of the world economy, it also ushered in a period of rebuilding and
renewed international competition led by the United States. This phase covers
the post Second World War period and runs to the present and is characterized
by the expansion of both capital accumulation and foreign direct investments by
multinational enterprises. This new era of the international economy is also
marked by a greater degree of international economic interdependence than
was witnessed in previous phases. Significantly, Makler’s (1978) transnational
capitalism phase has run concurrently with and been supported by the reestablishment of an organized international monetary system, the development
of advanced technologies that facilitated significant economies of scale in
production, and vast improvements and innovations in transportation and
communications. As a result, the dominance of the multinational enterprise in
international production was established during this phase.
American firms dominated the period from the end of the Second World War
into the 1960s.
It was only by the decade of the 1970s that American
multinational enterprises encountered significant competition from European
and Japanese firms. Newly industrializing countries of the periphery have also
begun to spawn globally competitive multinational enterprises in this modern
era (Muchlinski 1995:25-6).
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4.2.2 Post-war foreign direct investment policy
As the nature, structure and size of international firms changed over time, they
eventually came to dominate economic life, yet at the same time their
predominating presence caused reaction from the environment within which
they operated and led to attempts to restrain and control their potential for anticompetitive and other abuses. Muchlinski’s (1995:chapter 1) analysis takes us
forward from where Makler’s analysis ends. Muchlinski (1995) identifies the
post Second World War era as the period in which the issue of multinational
enterprises came to the forefront of contemporary political debate. The basis
for this positioning of multinational enterprises into the geo-political spotlight can
be attributed to a growing awareness in academic and popular circles of the
potential for the abuse of power especially by multinational enterprises
operating in developing host countries as had been demonstrated in a handful
of highly sensationalized cases. One of the most important cases in this regard
involves the attempted overthrow of the presidential administration of Salvador
Allende in Chile in the 1971 by the Central Intelligence Agency (CIA) in
cooperation with telecommunications giant International Telephone and
Telegraph (IT&T) (Muchlinski 1975:6-7; Cf. United States Senate Subcommittee
on Multinational Corporations 1973 cited in Modelski ed. 1979: chapter 14).
Although Makler’s analysis looks largely at the economic environment within
which multinational enterprises evolved, Muchlinski’s work focuses more
explicitly on the policy dimension of host states towards multinational
enterprises in the post World War II period.
Policies towards multinational
enterprises have, of design and necessity, differed across regions and
countries. The discussion to follow deals with a small but significant sample of
policy approaches applied in key regions and countries in the post Second
World War era. The sample of regions and countries includes Europe, Japan,
the United States and Africa.
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4.2.2 (a)
Whilst the Second World War left much of Europe’s physical and economic
infrastructure demolished, it also led to the rise of United States domination in
world trade and economic affairs. A natural manifestation of this development
was the rapid proliferation of United States multinational enterprises throughout
the world (Muchlinski 1995:3-4). By the 1960s, however, this trend began to
meet ideological resistance from Europeans in particular who began to express
misgivings about the overwhelming presence of United States firms in the
European market, particularly in crucial high tech industries. Ironically, it was
felt that although United States capital and business had played a major role in
rebuilding Europe, these same United States interests also stood to impede
European economic success if left unchecked.
Thus, the policy orientation
toward multinational enterprises in Europe by the early 1960s favored
regulation especially at the supranational level (Muchlinski 1995:3-4).
4.2.2 (b)
enterprises in the immediate post war era.
Unlike the situation in Europe,
Japan received far less foreign assistance in rebuilding its war torn
infrastructure and economy. Instead, Japan made extensive use of protective
trade barriers and highly restrictive policies on inward foreign direct investment.
Although the Japanese firmly restricted the entry of multinational enterprises
within their borders, they still managed to benefit from access to foreign capital
and technology by accepting foreign loans and licensing contracts. As one of
the few countries in the world with consistent foreign trade surpluses, Japan
drew attention and pressure from her major trading partners and the
Organization for Economic Cooperation and Development (OECD) to liberalize
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it’s foreign investment policies. This external pressure combined with pressures
from within Japan from a business community that feared restrictive trade
reprisals and wanted to guarantee themselves continued export markets and
access to foreign technology. These pressures lead to a gradual easing of
foreign investment policies from the late 1960s onward despite initial resistance
to reform from the state bureaucracy and special interest groups (Muchlinski
4.2.2 (c)
The United States of America
In the United States, the 1970s ushered in a period of intense public concern
and debate over both inward and outward foreign direct investment. On the
one hand, domestic United States firms lobbied for protection from cheap state
sponsored imports; and on the other hand, United States labor unions lobbied
for legislation that would curb the flow of outward direct investment as a way of
keeping jobs in the United States. Union efforts in this regard culminated with
the Burke-Hartke Bill of 1972. Although the Burke-Hartke Bill did not succeed in
being enacted into law, it’s foundational principles and policies continued to
influence import control laws. Since the congressional debate over the BurkeHartke Bill, United States economic policy has not attempted to limit outward
foreign direct investment but has put in place controls to review inward direct
investment into strategic and national security sectors (Muchlinski 1995:3-4).
4.2.2 (d)
On the African continent, the post-war era coincided with the reversal of the
colonial movement.
Thus, from around 1945 to 1975 the major European
powers (i.e. Britain, France, the Netherlands, Belgium, Spain and Portugal)
granted independence to their colonies in Africa and elsewhere. Despite the
fact that the majority of African countries gained independence during this
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period, this independence was essentially of a political nature only.
European powers continued to dominate the continent economically and
Economic domination took place firstly through trade which was
characterized by the uneven exchange of raw minerals out of the Africa for
manufactured goods from Europe, and secondly through the extraction of
excess rents and profits via private multinational European firms (Muchlinski
1995:3-4; Cf. Seidman and Seidman 1977:7-8).
As was discussed earlier in
the chapter, unindustrialized countries lacked the industrial and intellectual
capacity to undertake full production processes for finished goods and instead
acquired much needed foreign exchange by trading their agricultural and
mineral goods.
Although South Africa is now considered an industrialized
country, the government recognizes that there is still a lack of sufficient
beneficiation taking place in mining and minerals production.
Generally, African policy towards foreign direct investment in the early post war
period was articulated through African representation in the United Nations
under the aegis of the Group of 77. The Group of 77 (named after the 77 initial
member states that constituted it) was formed within the United Nations to give
a voice to the un-industrialized and developing countries in the United Nations.
The Group held an overwhelming majority in the United Nations and
represented an important source of pressure and reforms in the areas of
international, regional and unilateral foreign direct investment policies in the
underdeveloped and developing countries (Muchlinski 1995:5-6; Cf. Modelski
1979:265-8). The Group of 77 expressed deep reservations about the possible
negative effects of foreign direct investment in the newly independent and less
developed countries (LDCs) of the world. The Group of 77 thusly managed to
exercise its influence within the United Nations by getting a resolution passed to
have the Secretary General of the United Nations appoint a Group of Eminent
Persons to study and report on the effects of green-field foreign direct
investments of multinational enterprises on development in less developed
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Policies that emerged from the work of the Group of Eminent
Persons aimed to control the ability of multinational enterprises to (Muchlinski
Evade national regulation and taxation;
Use technological and capital endowments to monopolize markets;
Engage in non-economic abuses of the host state such as through
political subversion, the introduction of alien cultural values and
lifestyles, and the generation of intergovernmental confrontations
between home and host states.
The Group of Eminent Persons envisaged that these foundational and
ideological prescriptions would define the principles upon which host countries
of foreign direct investment could formulate their policies (Muchlinski 1995:5-6).
It was further envisioned that the abovementioned United Nations prescriptions
would be adopted at the levels of individual states, regionally and supranationally (Muchlinski 1995:5-6).
United Nations protocols on foreign direct
investment at that point in time were indirectly countered by the Organization for
Economic Cooperation and Development (OECD). By 1976, the OECD was
made up of twenty-four member sates, the majority of whom were industrialized
countries (such as the United States, Canada, Britain, France, Japan, and West
Although the OECD issued its “Declaration of International
Investment and Multinational Enterprises” its approach to the issue of foreign
direct investment seemingly favored the positions of industrialized/developed
countries over those of underdeveloped countries (Modelski 1979:265-6).
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policy orientations
representative of the current thinking on the regulation of the foreign direct
investment of multinational enterprises.
Since the 1970s there has been a
gradual shift towards openness globally and especially in the former socialist
states of the Eastern Bloc. There has also been an increase in the number of
countries that have introduced laws that aim to attract inward foreign direct
investment. The trend seems to be moving towards moderating tax and other
incentives to multinational enterprises with provisional requirements regarding
improved technology transfer, job creation and industrial development
(Muchklinski 1995:9-11; Cf. Dunning 1993:571-2). These largely global trends
and generalizations are decomposed to give a more detailed and regionally
specific analysis of foreign direct investment policy in the passages that follow.
Six factors that influence foreign direct investment policy
By integrating Makler’s (1982) work (which looks at the evolvement of firms into
multinational enterprises) with Muchlinski’s (1995) analysis of the historical
positioning of policies regulating multinational enterprises it can be argued that
foreign direct investment policies of host government'
s are highly influenced by
(or perhaps even determined by) the following six factors, namely (Cf. Dunning
1993:chapter 19,and pages 579-83; Cf. Muchlinski 1995:90-102):
(a) The growth and proliferation of multinational enterprises;
(b) Economic
competitive markets;
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(c) Economic
developmental objectives of host nations (especially in developing
(d) Social and cultural intrusion and domination;
(e) National sovereignty; and
(f) Legal concerns (with particular reference to corporate responsibility,
dispute resolution and international law).
Each of these will be discussed in turn in the following sections, with the
exception of the economic effects of inward foreign direct investment as this
has been covered earlier in the dissertation (Supra chapter 2) and will therefore
not be repeated here.
Growth and proliferation of multinational enterprises
Although academics and practitioners may not be in agreement on many of the
key points concerning the impacts of multinational enterprise investment,
empirical as well as anecdotal evidence clearly bears out the fact that as a
result of their phenomenal growth over the past half century, they have become
significant role players in the economic and political affairs of both host and
home countries (1974 United Nations Report cited in Modelski 1979:309).
Generally, in the policy process and in the political environment, unanticipated
change and the pace of that change causes immediacy of response and
reformulation of priorities. Thus, large-scale and rapid institutional, structural or
environmental change that may have some bearing on the public interest will
usually lead to calls from the electorate for policy responses on the part of the
elected. In this regard, by the decade of the 1960s, world attention, academic
literature and public policy were drawn to multinational enterprise at a time
directly corresponding with their most active rate of proliferation (Muchlinski
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1995:3-7); The United Nations Department of Economic and Social Affairs
(1973 United Nations Report cited in Modelski 1979:23-4), expressed major
reservations about the fact that –
“… The value added by each of the top ten multinational corporations in
1971 was in excess of $3 billion – or greater than the gross national
product of over 80 countries.
The value added of all multinational
corporations, estimated roughly at $500 billion in 1971, was about onefifth of world gross national product, not including the centrally planned
[Thus], International production, defined as production
subject to foreign control or decision and measured by the sales of
foreign affiliates of multinational corporations, has surpassed trade as
the main vehicle of international economic exchange. It is estimated that
international production reached approximately $330 billion in 1971.
This was somewhat larger than total exports of all market economies
($310 billion).”
Although readily verifiable, statistical comparisons of this kind (i.e. between the
profit margins of multinationals and the gross national product of countries) may
or may not have signaled any significant relationship in real as opposed to
perceived terms (1973 United Nations Report cited in Modelski 1979:23-4;
Dunning 1993:6-10). Instead, this information tends to serve more explicitly to
shed some light on the motivations, composition of and/or changes in the policy
environment during the decades of the 1960s and 1970s.
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Further, although the growth and proliferation of the multinational enterprise has
been identified as an important factor in the determination of multinational
enterprise regulatory policy, this growth and proliferation was in turn determined
by a number of other factors including the following (Dunning 1993:105-9; Cf.
Spybey 1992:135; Cf. Muchlinski 1995:22):
1. The industrial revolution and its technological and legal innovations;
2. Foreign raw material and mineral wealth and availability; and
3. Overcoming tariff barriers.
Significance of the Industrial Revolution
Historians and economists are unable to set a definitive timeframe within which
the multinational form of business commenced. Scholars of this field prefer to
date the beginnings of this form of business enterprise with the period(s) in
history when their activity and influence was most significant. Thus, although
historical references can be affirmed as far back as the colonizing activities and
enterprises of the Phoenicians and the Romans, and at later stages in history to
the colonizing period of the Europeans in South America and Africa (Dunning
1993:96; Cf. Muchlinski 1995: chapter 2), the relevant period is the Industrial
Revolution - which is described as the birth of the modern multinationals
(Spybey 1992:135; Muchlinski 1995:19-20).
Mass production and important mechanical inventions and innovations that
occurred during this period expedited the expansion of production capacity and
increased profits and reinvestment capital, which in turn facilitated increased
international trade and opportunities for international production by multinational
enterprises. Of the many innovations of this era, mass communication and
mass transportation (combined with improved business and management
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strategies) were amongst the key elements in the proliferation of foreign direct
investment (Spybey 1992:135).
The industrial revolution is also slated as the period in which a change in the
legal structuring of large business enterprises facilitated their national and
international expansion (Spybey 1992:135).
Due to the large amount of
financial capital required to launch large-scale production facilities, shared
ownership through the joint-stock company arrangement had existed since at
least the Middle Ages. Spybey (1992) notes that with the introduction of the
limited liability legal concept during the second half of the nineteenth century,
shareholding became less risky and more attractive as investors were held
liable for debts of the company only to extent of their original investment or
shareholding. Thus the debt burden in cases of liquidation or insolvency was
shared proportionally amongst investors. In other words, an investor could not
lose more than his equity share invested in a limited liability company. The
popularity of this type of legal business entity was sufficient, at that time, to
precipitate the development of capital markets in all the industrialized countries.
A secondary consequence of the development of capital markets was the
growth, development and proliferation of multinational enterprises that were
able to easily access capital markets for the procurement of investment capital
(Spybey 1992:135). Thus, it can be noted that the introduction of the limited
liability form of business was a significant factor that contributed to the
proliferation of multinational enterprises in the period of the industrial revolution.
Multinantional enterprises in search of raw materials
Another important factor that contributed to the proliferation of multinational
enterprises was the lack of natural resources and minerals in the home
countries of the multinational enterprises. Muchlinksi'
s (1995:22) analysis of the
half century or so prior to the First World War decomposes world distribution of
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direct foreign investment by industry as follow: 55 percent in primary products
(i.e. raw materials and agriculture), 20 percent in railways, 15 percent in
manufacturing and 10 percent in trade and distribution, with the remainder in
public utilities and financial services. The emphasis on primary products during
this period coincides with the gearing of the industrial revolution and is
indicative of the reliance, at that time, of the industrializing world on the less
industrialized third world countries for the provision of raw material and mineral
Overcoming tariff barriers
In essence firms that have sufficient capital and asset endowments have the
option of exporting to foreign markets, licensing their products to local
producers in foreign markets, or establishing their own production facilities
abroad (Caves 1996:27).
An important factor determining which of these
options is followed is the global incidence of import trade tariffs. The existence
of high tariffs and import quotas has been forwarded as a motivating factor for
the proliferation of international production. The rationale here is that where
foreign domestic markets are restrictive towards imports, the international
enterprise will prefer to avoid high import charges (in the form of tariffs, quotas
and other import limiting measures) by setting up production facilities in those
In this regard, Muchlinski (1995:23) has identified the inter- war period 1918 1939 as a period of growth and proliferation of multinational enterprises that
was significantly above the pre-war levels (i.e. prior to 1914). This Muchlinski
(1995) associates or attributes to the relatively high tariff barriers endemic
during the period surrounding the First World War. These high tariff levels in
turn were representative of the highly nationalistic, import substituting economic
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policies engaged in by states prior to and during the war years as a means of
shielding themselves against the world depression (Muchlinski 1995:23).
4.3.1 (b)
Social effects associated with inward foreign direct investment
A key concern of the United Nations with regards to the issue of foreign direct
investment in the post war era is the social dimension. The Merriam-Webster
Dictionary (1992:684) defines the word social as – naturally living and growing
in groups or communities. For the purposes specific to this thesis, the term
‘social dimension’ is defined as the shared traditions, customs, belief systems,
and norms that serve to define a group of people. Given the latter definition,
social dimension can be seen as being made up of a number of elemental
parts, these parts themselves being alternatively and collectively defined as
culture (Cf. Daniels and Radebaugh 2001:47). Thus the terms social dimension
and culture are used interchangeably.
The pragmatism of this definitional exercise serves to enhance the general
understanding of the policy framework aimed at addressing issues in the social
dimension (i.e. the social effects associated with inward foreign direct
investment). In terms of foreign direct investment policies coming from the
United Nations, as indicated above (Supra - sect. 4.2.2), the Group of Eminent
Persons in the United Nations aimed to prevent, through regulation, the ability
of multinational enterprises to engage in non-economic abuses of the host state
such as through political subversion, the introduction of alien cultural values and
lifestyles, and the generation of intergovernmental confrontations between
home and host states (Muchlinski 1995:6).
Focusing on the cultural aspect of non-economic abuses of the host state by
multinational enterprises, Daniels and Radebaugh (2001:50) suggest that the
appropriate scope for analysis is the nation-state.
This is because “…the
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similarities among people is both a cause and an effect of national
boundaries…[and also] the laws governing business operations apply primarily
along national lines.” Thus, within the nation-state, culture can be analyzed in
terms of (Muchlinski 1995:6):
1. its method of sustaining itself via transmission and adoption from one
generation to the next; and
2. the manner in which it evolves.
In terms of transmission, culture is normally successfully transferred by way of
observation and verbal communication and flows in the direction of parent to
child, or teacher to pupil, or social leader to follower(s), and also even from one
peer to another (Muchlinski 1995:6). In terms of cultural evolution, this can
either be voluntary or forced/imposed (forced cultural change is also commonly
referred to as cultural imperialism). Voluntary change occurs when the culture
is not interfered with in any way by other cultures, but instead natural
environmental conditions change and the culture adapts itself to such changes.
An example of voluntary change is when a significant drop in agricultural
productivity, due to natural environmental changes such as drought and soil
erosion, causes migration from rural and farming areas to urban areas. This is
in contrast to forced cultural change where the direct cause of the change in
culture is the introduction of foreign cultural elements (Muchlinski 1995:6).
Daniels and Radebaugh (2001:50) note that multinational enterprises tend to be
conduits of imposed cultural change and thusly governments have attempted to
control the entry and business practices of multinational enterprises in order to
protect some semblance of their cultural identity and heritage.
The two principal, and diametrically opposing, arguments concerning the
modernization theory on the one hand and dependency theory on the other.
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Whereas modernization theory tend to be overly optimistic about the ease and
appropriateness of transforming cultures of underdeveloped countries into
Western style cultures, dependency theory is extremely pessimistic of such
transformations and proposes that the very structure of the capitalist worldeconomy creates unequal development internationally and in-equitable
distribution of public resources domestically (Robock and Simmonds 1989:310;
Spybey 1992:1). Spybey (1992:134-5) argues that a more accurate reflection
of cultural change vis-à-vis international investment lies somewhere in the
ideological center of the continuum between these two polar extremes. In this
regard Spybey (1992) characterizes the organizational structure and behavior
of MNEs as being conducive to, but not guaranteeing, social control and
manipulation by enabling certain social, political and economic activities while
restraining others. Spbey’s (1992) claim is partly supported and documented
by Taylor and Thrift (1982:296) who find that “…the recent intensification in the
center’s use of peripheral resources, markets and labor has been accompanied
by an intensification of cultural domination.”
Corporate advertising on a global scale, is yet another and, perhaps the most
important mechanism through which multinational enterprises influence cultural
change (Taylor and Thrift 1982:276-7; Dunning 1993:536). By necessity, mass
production and commodity supply on a global scale require the development of
mass markets that will demand these global products.
In turn, the
establishment of the demand for the multinational enterprises products is
normally accomplished through advertising that aims at creating a global
homogenization of cultural wants, needs, tastes and behaviors (Ewan 1976:12
cited in Taylor and Thrift 1982:291). As previously noted, governments that fear
compromising their unique cultural identity due to the business activities of
multinational enterprises will consider regulatory control measures as a stopgap solution (Dunning 1993:534-5).
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4.3.1 (c)
National sovereignty
The more extreme but less frequently occurring justification for multinational
enterprise regulation is that of the perceived threat of contravention of national
sovereignty by multinational enterprises through political, social, cultural and
economic obstruction or intervention (Dunning 1993:19; Sunkel in Modelski ed.
National sovereignty issues, as a basis for multinational enterprise
regulation, have found expression in the legislation of almost all countries that
maintain some level of policy on foreign direct investment.
geographic demarcation and distinction can be drawn between those countries
and global regions that give greater consideration to the national sovereignty
issue and those that give it a more subordinate position in their foreign direct
investment policy. In respect of these generalized policy stances (rooted in the
sovereignty debate) and based on informed research of foreign direct
investment policy, these geographical divisions can be made as follows
(Spybey 1992: part IV):
Middle Eastern, Latin American, Sub-Saharan Africa, Eastern Europe, Asia,
East Asia, The United States, United Kingdom and Western Europe.
discussion here will be limited to the three most relevant areas in terms of the
sovereignty issue.
Central and Latin America
Dependency theorists broadly contend that although the former European
colonies were granted political independence, their inherited economic
arrangements essentially remained dependent on servicing the enterprises and
markets of their colonizers (Spybey 1992:20; Muchlinski 1995: 98-9). Further,
even after gaining complete independence the continuing domination of these
newly independent states was subsequently exercised through the exploitative
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investments of the earliest European (and American) multinational enterprises
within their borders.
These investments were (and for several generations
continued to be) in primary production and mining.
Thus, foreign direct
investment activity amounted to an exchange of low-priced raw materials from
developing countries for high-priced manufactured goods from the industrialized
countries (Spybey 1992:159).
This ‘unequal exchange’ was in essence the
primary objection to multinational enterprise investment extended by the
dependency school and their focus for policy reform.
Perhaps as a result of their actual experiences with foreign investors, and/or
based on a strong nationalistic and cultural identity (Dunning 1993:532-3),
Central and Latin American countries gave new momentum to dependency
theory during the period of the 1930s to the 1970s.
For South American
economists of that era '
dependencia'came to represent not only a connotative
description of a set of international economic conditions but also more
importantly, ‘dependencia’ as an ideology perpetuated a highly influential
political movement that brought about significant change in foreign investment
policy in this geographic region.
Thus, ‘dependencia’ was the driving force
behind the restrictive policy approach adopted by the Latin Americans
(Muchlinski 1995:98-9; Cf. Sunkel 1972 in Modelski (ed.) 1979:chapter 13; Cf.
Spybey 1992:23-7).
The culminating points of this political movement took place in Chile under the
presidency of Salvador Allende, with the nationalization of American oil
companies in Chile and the subsequent subversive efforts by International
telephone and telegraph (ITT) to overthrow his administration (United States
Senate 1973 cited in Modelski ed. 1979: chapter 14). ‘Dependencia’ was
concerned not only with the economic situation, but was also concerned
secondarily with social and cultural domination.
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Middle East and Islamic States
National sovereignty concerns have been much more pronounced in this region
of the world than in most others.
Further, the key difference between the
degree of nationalism expressed in this part of the world as opposed to others,
is that almost every condition of life – social, political and economic is carried
out according to strict adherence to the rules of the region’s dominant religious
doctrine which is Islam. Thus, for example, ‘Islamic Law’ affects the business
community by prohibiting the charging of interest in any and all interactions
(Spybey 1992:213). Beyond this, there have been periods (especially in the
1980s) in which a clear contempt for foreign influence (especially Western) was
In fact, history demonstrates that the culture, politics and economies of this
region until relatively recently remained free of Western influence (Spybey
1992:213). Western colonialism did not extend into the Arab States due in large
part to the impervious rule of successive Islamic empires. As a consequence,
European maritime activities required the circumvention of these territories in
order to reach India and the Far East.
The Second World War, however, involved the Arab states tangentially as the
French and British allied forces came to the assistance of the Arab states in
their battle against the German supported Turks.
The conclusion of WWII
ironically brought the Middle East under the control of the allied forces who
adopted a divide and conquer strategy to their encroachment into the region.
France obtained a League of Nations’ mandate over Lebanon and Syria, with
significant oil concessions in Iraq, whilst the British mandate apportioned to
themselves Iraq, Palestine and Transjordan. Later, with the discovery of major
oil fields in the Saudi Arabian peninsula, the USA also gained major oil
concessions there.
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Thus, Western capitalists have maintained a formidable investment presence in
this region since discovering the vast oil reserves contained therein (Spybey
1992:213). This discovery coincided with the end of the First World War and
the fall of the Ottoman Empire (Spybey 1992:210). Further, despite the general
rejection of foreign culture and influence in the Middle East and the domination
of society by Islamic dogma, these sets of conditions has not resulted in
autarkic economic relations with the rest of the World.
Whilst maintaining
economic relations with Western business interests, the political and social
nationalist phenomenon was directed most strongly toward the Western
powers. A key event leading to this build-up of resentment toward the West can
be attributed to the creation of a Jewish state within Palestine.
This Jewish state was the product of British foreign policy under the Balfour
Declaration of 1917 and has enjoyed substantial financial and military support
of the Western allies especially the United States of America. Two major wars
and the numerous lesser military conflicts between Israel and the mobilized and
united Arab states served as a prelude to the complex and uneasy relationship
that currently exists between foreign investors and governments in the Middle
Further, the rise to power of Ayatollah Khomeini in Iran in 1979 marked a
significant move toward Islamic fundamentalism and anti-western sentiment in
the region. Other influential leaders in this movement (circa 1980’s) include
Moamar Khadafi of Libya, and Sadam Hussain of Iraq.
Thus, as Dunning
(1993:533) generally points out concerning the Middle East “…notably [in] Iran
and Iraq, the contemporary resurgence of Islamic fundamentalism is dominating
all trading relationships with the outside world. Their unwillingness to accept
inward direct investment from countries whose economic policies and cultures
are perceived to undermine these beliefs is hardly less great than the
communist world less than a decade ago”.
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The Former Soviet Union and Eastern Europe
The current foreign direct investment policy approach in this region of the world
can be characterized as a complete revision and reversal of past policies
followed by these formally socialist governments (Muchlinski 1995:23). This
dynamic transformation in foreign direct investment policy approach necessarily
is taking place in an environment of uncertainty as this change in policy
represents a microcosm of the larger transition from socialist economies to
capitalist market economies. This greater transition in ideology came about in
the late 1980s and early to mid 1990s after socialism endured approximately
one hundred years in the former Soviet Union and fifty years in Eastern and
Central Europe. Understandably the details of foreign direct investment policy
have not been clearly worked out relative to other areas of economic policy
reforms. One of the key issues currently being addressed in this regard is the
issue of privatization and private property rights.
Although foreign investment and privatization are the agenda issues of the day
in this region, history of the socialist movement in the Soviet Union and Eastern
Europe indicates
that the national sovereignty issue was the primary driving
force behind much of government policy to date - both domestic and
international. Foreign direct investment policy, as an extension of international
relations was thus characterized by a closed system of trade and investment
limited to the CMEA (Council for Mutual Economic Assistance) countries
(Bleaney 1988:52).
A cursory examination of the socialist economic mechanism reveals that foreign
direct investment was essentially non-existent. That is, since the state owned
and/or controlled all means of production (both agricultural and industrial), the
possibility of foreign direct investment was not a reality at this point in history.
However, one aspect of the national sovereignty issue showed itself by way of
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the massive military buildup during the cold war. Since at least the 1950s, the
Soviet leadership was determined to compete with the West (especially the
USA) on economic, technological and military grounds (further, they were
determined to prove the superiority of their socialist system of government).
Early successes in all three of these areas in the 50s and 60s were met with
steady decline in the 70s and 80s (the military priority being the exception)
(Bleaney 1988:Chapter 2). Political upheavals in the region combined with the
systematic failures of technology and economy led to the fall of the Berlin Wall
in 1989 and the disintegration of the Soviet Union in 1991.
Currently, this region is in an embryonic stage of economic policy development
as it moves away from the central planning model towards integration into the
international economy. It should be noted, however, that a number of states in
the region now have in place advanced measures concerning foreign direct
investment. For example, the protection of foreign investments is guaranteed in
Estonia with relevant laws and international agreements. Also on the books are
bilateral agreements on the promotion and protection of investments, which
have, been concluded with Switzerland, Germany and the United States of
America as well as taxation avoidance and double taxation agreements with a
number of other states.
However, for the region as a whole, the major
stumbling block (as noted above) is the inconsistency contained in the property
rights issue.
4.3.1 (d)
Multinational enterprises, corporate responsibility and international
The very nature of the multinational enterprise, that is a business enterprise
legally incorporated in one country and conducting it'
s business affairs in a
number of different countries, opens up the possibility of avoidance of
accountability in the legal domain. In this regard, a number of well documented
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cases – for example, Union Carbide in Bhopal India, and Cape Plc. in South
Africa – reveal that local as well as international law has, to date, not offered
adequate and/or timely solutions to problems arising in cases dealing with
extraterritorial jurisdiction. This is evidenced by the fact that the fundamental
principle of international law is to confer upon each state exclusive sovereignty
over the territory it controls (Muchlinski 1995:124).
Strict adherence to this
principle carries with it the corollary duty of non-intervention on the part of other
states. Thus, this requirement of non-intervention essentially negates the ability
of states to pursue legal claims against their home-country firms located in
foreign jurisdictions.
In fact, as Muchlinksi states "…any assertion of
extraterritorial jurisdiction by a state would amount to a violation of international
law. Such a view might be unduly restrictive of a state'
s legitimate interest in
the effective enforcement of its laws against [multinational enterprises] MNEs."
A highly instructive, and perhaps deterministic, case for the South African legal
and regulatory framework on inward foreign direct investment is the case of
Lubbe vs. Cape Plc.
Cape Plc is an asbestos mining, processing and
distributing company whose articles of incorporation are founded in England in
1893 under the name – Cape Asbestos Company Limited (Westlaw 2003; Van
Niekerk 2001; Coombs 2002). Cape Plc, had been engaged in asbestos mining
in South Africa from 1893 to 1979, mainly in what is now the Northern Cape
Province and Limpopo Province.
It also began operating an asbestos
processing factory in Benoni near Johannesburg in 1940. From 1948 its South
African business activities were conducted through wholly owned subsidiaries
with head offices in Johannesburg. In 1979 the company sold all its mining and
mining related interests in South Africa, with the exception of its Benoni factory,
to a local company. In 1989 it sold the Benoni factory and has since then
ceased to have any physical presence or assets in South Africa, thus effectively
putting itself out of jurisdictional reach of the South African legal system.
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In 1997 the first of 11 writs was served on Cape Plc, the defendant, in England
by South African plaintiffs. The basis for this lawsuit can be summarized as
7,500 South African plaintiffs, resident in South Africa, claimed damages
for personal injuries (and in some cases death) allegedly suffered as the
result of exposure to asbestos and its related products that were mined,
processed and distributed in South Africa by Cape Plc during its tenure
in the country.
the claim is made against the defendant as a parent company which,
allegedly knowing that exposure to asbestos was gravely injurious to
health, failed to take proper steps to ensure that proper working practices
were followed and proper safety precautions observed. In this way, it is
contended that, the defendant breached a duty of care which it owed to
those working for its subsidiaries or living in the area of their operations,
with the result that the plaintiffs thereby suffered personal injury and loss.
The major stumbling block to resolving this case was the issue of
whether the proceedings brought by the plaintiffs against the defendant
should be tried in England or in South Africa. It took several court cases
and two Appeals Court hearings in England to resolve this issue before
the case could be heard in the House of Lords of the English court
With regards to the issue of the appropriate forum in which to hear the case,
arguments centered around common law principles set in a similar case,
Spiliada Maritime Corporation v. Cansulex Ltd. [1987] A.C. 460, heard before
the House of Lords of the English legal system. On the basis of the precedence
set in Spiliada, if it can be successfully argued that a foreign plaintiff will not
obtain justice against an English defendant in the plaintiff’s home country, the
English court may not grant a stay (a refusal) to have the case heard in
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England. By the conclusion of the hearings in the second Court of Appeals,
Lubbe v. Cape Plc. passed the Spiliada test, thus favoring having the case
heard in England.
The plaintiffs further argued that a second test for assigning the case to the
British courts is that of Article 6 of the European Convention on Human Rights.
As Article 6 is consistent with the Spiliada test in principle, it was successfully
argued that granting a stay of the proceedings in favor of South Africa as the
legal forum would amount to a violation of the Article since the lack of funding
and legal representation that the plaintiffs encountered in South Africa would
deny them a fair trial on terms of litigious equality with the defendant.
Comparing Lubbe v. Cape Plc. with an earlier case against Cape Plc., Gisondi
v. Cape Plc., demonstrates the lack of adequate protection for South African
complainants in certain cases of extraterritorial jurisdiction. Vincenzina Gisondi
and three other Italian plaintiffs successfully sued Cape Plc. for damages in
England. There are numerous similarities, with the Lubbe case, in terms of
both the nature of the writs and arguments presented with one critical exception
– i.e. attorneys for Gisondi successfully argued for consideration under Article 2
of the Brussels Convention to which both England and Italy are signatory
states. Under Article 2 of the Brussels Convention the English courts were
compelled to not decline jurisdiction in favor of the Italian legal system and
accordingly the defendant had no opportunity to apply for a stay on the grounds
of forum non conveniens (inappropriate forum). Unfortunately for South African
claimants, international agreements that make up the Brussels Convention only
apply to states that are party to the Convention, thus South African claimants
bear a greater burden than some of their counterparts in pursuing legal remedy
in foreign courts.
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South Africa has on the whole always maintained an open stance towards
inward foreign direct investment.
The disruptions in these inward flows,
experienced in the 1970s and 1980s, were externally generated (through
divestment, dis-investment and embargos) as opposed to being the result of a
change to a more closed regulatory regime on the part of government. It has
been demonstrated in this chapter that most other countries and regions of the
world have felt the need not only to regulate inward foreign direct investment,
but have also felt the need to regularly review these policies as internal and
external environmental circumstances changed.
As policy based on theory cannot always take account of all counterfactual
possibilities, there are often loopholes in laws and policies that are to be
exploited. It is therefore the norm that case studies have been the driving force
for change. In particular, the case involving the attempted overthrow of the
Chilean government by telecommunications giant ITT and the CIA brought with
it renewed awareness of possible abuses of a foreign multinational enterprise
within a host country and suggested new policy options for governments to
Another important case, especially for South African foreign direct
investment policy, is that of Lubbe v. Cape Plc. in which a British company,
Cape Plc., owned and operated asbestos mining and processing concerns in
South Africa for almost 100 years. By 1989 the company no longer had a
physical presence in the country and was therefore beyond the reach of South
African law and South African claimants seeking compensation for alleged
asbestos poisoning due to the negligent conduct of the company. Although the
case was eventually settled in 2001 in England, the difficulties experienced in
getting to that stage provide valuable lessons for a renewed assessment of
South African government policy. In this regard, the Brussels Convention, in
Article 2, provides a model that should be considered for South Africa.
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Chapter 5
Critical Review of Existing Policies on Foreign Direct Investment
in South Africa
Given that the purpose of this dissertation is to determine the efficiency
prospects offered by way of the rationalization of government structures that are
involved in the regulation of foreign direct investment policy, it must be noted that
examination of these structures cannot take place in isolation of the underlying
policies. These policies must first be understood and articulated before their
implementing structured can be evaluated. To this end the current chapter first
sets out to get clarification on what is meant by the term policy and how the
process of policy determination is realized. Further, a survey of foreign direct
investment and/or multinational enterprise policies in South Africa is undertaken
in order to give clarity to where specific policies are housed as well as how they
are administered in relation to other policies in the same area.
Comparatively, foreign direct investment and multinational enterprise policies that
have been applied in other countries are surveyed in order to examine alternative
policy options that may (or may not) prove effective in the South African context.
This chapter serves as a prelude to next chapter that examines if rationalization
and/or re-organization may provide the necessary framework under which foreign
direct investment and multinational enterprise policy can be more effectively
delivered than is currently the case.
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Public policy defined
Parsons (1995:2) gives pragmatic value to the term public policy by defining
separately and then examining together it’s component parts. Thus he defines
‘public’ at great length before tackling the definition of ‘policy’ with the same zeal.
The integration of these two terms/concepts is then derived. In short, Parsons
defines public (in relation to private) as encompassing that sphere of life that is
not purely private, but is instead the common domain of all in society. More
specifically, Parsons defines public as comprising “that dimension of human
activity which is regarded as requiring governmental or social regulation or
intervention, or at least common action” (Parsons 1995:3).
Although this
definition recognizes the interventionist role of government, it is not entirely
inconsistent with the laissez faire principle and the belief that market forces left to
their own devises would maximize the welfare of not only individuals in markets
but also that of the public at large. Instead, the role of the state was seen to be
that of merely creating and maintaining ‘free’ market conditions through limited
intervention in the economy and the maintenance of law and order (Gildenhuys
1997:2-8). The term public thusly accurately refers to all areas of activity of the
state as defined here.
Of the many definitions offered for the term policy, a fairly succinct definition is
that offered by Anderson (1975:3) who states that a policy is: “A purposive
course of action followed by an actor or set of actors in dealing with a problem or
matter of concern”. This definition regards policy as what is actually done (a
purposive course of action) as opposed to what is proposed, decided upon or
Further, this definition also requires the clear identification and
specification of a problem, the resolution of which requires policy intervention.
Combining the aforementioned definitions of public and of policy, it can be
ascertained that public policy as an integrated term refers to problem solving
actions undertaken by government.
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Public policy and change
Policies tend to be dynamic in nature. Policy change can be viewed as taking
place within the context of one or more of four ideal types of change: policy
innovation, policy succession, policy maintenance and termination (Hogwood and
Peters 1983:26; Cf. Brewer and de Leon 1983:17-21). Each of these types of
policy change are briefly discussed hereunder.
Policy Innovation
Policy innovation represents the creation of a new area of policy that occurs as a
result of the entry of an institution/governmental unit into an activity in which it
has not previously been involved. The key challenge faced by the institution in
attempting such an endeavor is the fact that newly established organizational,
legislative and budgetary provisions normally start from an unstable base
founded in an uncertain environment.
The level of complexity of policy
innovation can thus be expected to greatly surpass that of other types of policy
changes that merely involve changes to already existing organizational structures
and policy regimes (Hogwood and Peters 1983:26-9).
Policy succession
Policy succession, on the other hand, refers to significant modification or outright
replacement of standing policies (and their organizational structures) as a
strategy to adapt the organization to internal and/or environmental change. This
type of policy change does not, by definition, involve the organization engaging in
a new field of activity. Instead, under this type of policy change the objectives
(ends) remain the same while the mechanisms of program delivery (means) are
changed (Hogwood and Peters 1983:26-9).
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Policy maintenance
Alternatively, policy maintenance can be thought of as the continuous monitoring
and amending of standing policies.
Unlike policy innovation and policy
succession, policy maintenance does not involve, to any significant extent,
changing either the objectives (ends) or the means of the organization. Instead,
policy maintenance changes are characterized by the attempt to improve upon
the use of existing program delivery mechanisms (means) in order to conform to
the original policy objectives (ends) (Hogwood and Peters 1983:26-9).
5.3.4 Policy termination
Lastly, policy termination involves the complete or partial dissolution of
organizational structures and the attendant legislation thereof, as well as the
complete cessation of public expenditure on policy related activities and
programs. Although policy termination is a rare form of policy change in the
public sector, it’s importance lies in the fact that it calls for the continuous
evaluation of organizations and their policies, activities and programs and further
calls for their termination where this is justified from an effectivity and efficiency
basis (Hogwood and Peters 1983:26-9; Cf. Brewer and de Leon 1983:20-1).
Public Policy Determinants
Other important influences over and possible determinants of public policies are
public policy role players, public policy formulation processes, and the legislative
processes required for the enactment of government reorganizations and
rationalization. A brief discussion of each of these factors follows.
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Public policy role players
Although the activity of formulating public policy is normally concluded at some
level (usually top)
within the government administration, public policy
development is not the exclusive domain of any person or assemblage of
persons either within or outside of government. Rather, all citizens [and noncitizens who have an interest (ex. financial) in a given country] are able to affect
public policy with varying degrees of influence. Anderson (1975) addresses this
point by differentiating between the more influential official policy makers and the
usually less influential unofficial policy-makers (Anderson 1975:37-48; Cf.
Hanekom 1987:21).
Official policy-makers are those policy-makers whose
official decisions are recognized as legally binding.
Included among this
grouping of individuals are legislators, executives, administrators and judges. It
is not, however, uncommon for these public policy actors to be influenced and/or
controlled by unofficial policy-makers, such as political party bosses and special
interest groups.
Unofficial policy-makers, on the other hand, have no legal endorsement of their
decisions and wishes, although they may be able to influence policy through
pressure exerted on official policy-makers. Included in this grouping of persons
are special interest groups, political parties, non-governmental organizations
(NGOs) and citizens based organizations (CBOs).
Public policy formulation
Upon receipt of policy proposals from the administrative and executive branches
of government, legislators must engage in the process of debate, amendment,
ratification and enactment on those policy proposals that they consider to be
worthwhile. Policy formulation at the legislative level of government is thus a
two-stage process that includes firstly, deciding what should (or should not) be
done to resolve a particular problem, and secondly drafting legislation to give
University of Pretoria etd – Moeti, K B (2005)
effect to the solutions decided upon (Anderson 1975:70; Cf. Gildenhuys 1997:
chapter 4). Bills that have been passed into law (Acts) represent an important
indicator of the actual content of public policy (Anderson 1975:70).
Rationalization within the public policy process
The authority to execute structural change by way of rationalization or
reorganization within the South African government administration is shared
amongst the Executive and Legislative branches of government, with the
Judiciary playing a secondary role given it’s mandate to make a determination as
to the constitutionality of the agency in question and the procedures to be
followed for its creation (Roux et. al 1997:chapter 3; Cf. Cloete 1998:chapter 4).
The Constitution of the Republic of South Africa,1996, Act 108 of 1996 confers
legislative authority upon the bicameral Parliament which consists of the National
Assembly and the National Council of Provinces. The procedures for getting a
bill passed - in this case a bill concerned with an administrative reorganization are based on the system of checks and balances whereby both divisions of
Parliament as well as the President must scrutinize the bill before it is signed into
law by the President.
Section 75(1) of the Constitution stipulates that a bill
originating from and passed in the National Assembly must be forwarded to the
National Council of Provinces for consideration. If the bill is also passed by the
National Council of Provinces without amendments, it then must be submitted to
the President for assent.
If, however, the bill is rejected by the Council or
affirmed by the Council subject to amended changes, the bill must be returned to
the Assembly for reconsideration before resubmission to the President for
assent. In the case of matters dealing with Provincial affairs, Section 76 (2) of
the constitution specifies the reverse order of the procedure of Section 75(1)
such that when the National Council of Provinces passes a bill it must be
submitted to the National Assembly for consideration before being presented to
the President for assent.
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The President is also a significant role player in administrative reorganization as
the President possesses not only the affirming vote on legislative matters vis-àvis signing a bill into law; but the President also maintains the constitutional
authority to prepare and initiate legislation; develop and implement national
policy; appoint commissions of inquiry; as well as being responsible for
coordinating the functions of state departments and administrations. [Sections 84
and 85 of the Constitution of South Africa 1996 (Act 108 of 1996)].
Review of FDI/MNE policies – South Africa
Policies can either be explicit or implicit. Explicit policies are often referred to as
rules since they clearly state what is or is not to be done, whereas implicit
policies are open to interpretation and merely provide guidelines for those
charged with their implementation (Roux et. al 1997:125; Cf. Brewer and de Leon
1983:268). This being noted, it can further be stated that policies can exist even
though they have not been clearly articulated or documented. Although it may be
correctly stated that there is no institutional unit within which foreign direct
investment policy is coordinated in the South African public sector, it is not the
case that these policies are non-existent. Several departments and sub-units
hold some responsibility in the formulation and implementation of foreign
investment policy.
Thus for example, the South African Reserve Bank is in
charge of regulating exchange controls that put limits on the amount of money
and other capital assets that can be brought into or taken out of the country;
while the Company registrar’s office under the Department of Trade and Industry
is responsible for setting registration requirements for internal (domestic) and
external (foreign) companies while at the same time several subunits under the
Department of Trade and Industry provide investment and export incentives to
foreign investors in order to attract greater amounts of foreign direct investment.
This section of the current chapter is ultimately concerned with the possibility of
putting in place a government structure that would coordinate all areas of policy
involving foreign direct investment in order to provide a consistent and measured
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approach to determining the appropriate forms and levels of foreign direct
investment policies. The underlying questions that need to be raised in this
regard relate to whether or not the Government is engaged in unhealthy and
excessive competition with other governments to attract foreign direct
investment; and are all governmental units that regulate some aspect of foreign
direct investment acting in a unified and coordinated manner in formulating their
The discussion that follows attempts to partially resolve these two questions by
conducting a critical review of the foreign direct investment policies that exist in
each of the following governmental units: the Department of Trade and Industry;
the Competition Commission; the South African Reserve Bank; the Department
of Environmental Affairs and Tourism, and the Department of Minerals and
Energy (for a comprehensive summary see Table 5/1 below).
5.5.1 Department of Trade and Industry
A synoptic picture of the policy approach of the South African government
towards multinational enterprises and foreign direct investment can be
constructed mainly from the work of the Department of Trade and Industry and its
affiliated governmental and quasi-governmental organizations.
In order to
counteract the low savings and investment rates occurring in the economy, the
Department of Trade and Industry has set for itself a key strategic objective of
promoting domestic and foreign direct investment. This object is being pursued
primarily through concentrating investments into Spatial Development Initiatives
(SDIs). Spatial Development Initiatives represent one of the Government'
s key
industrial policies aimed at fostering sustainable industrial development in areas
with viable economic potential but where poverty and unemployment rates are
amongst the highest in the nation (South Africa Yearbook 1999:288-90).
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The Department of Trade and Industry also pursues more generic investment
promotion initiatives aimed at foreign investors such as marketing South Africa
as an investment destination, conducting investment missions, investment
facilitation services, and investment incentives
(Accelerating Growth and
The contribution of an integrated manufacturing strategy –
Department of Trade and Industry, 2003:46-7). A primary example of the type of
investment incentives offered for foreign investors is the Foreign Investment
Grant (FIG). The Foreign Investment Grant provides 15% cost recovery (up to a
maximum amount of R3m per entity) for foreign entrepreneurs to transport into
South Africa, new machinery and equipment as part of their invested capital (DTI
website 2004).
Other support mechanisms employed by the Department of Trade and Industry
to support foreign direct investment include the Foreign Direct Investment
Scheme (FDIS), the Export Marketing & Investment Assistance Scheme (EMIA),
and the Inward Investment Missions Scheme (IIMS) all of which provide financial
assistance to exporters to partially cover costs incurred in the process of
recruiting new foreign direct investment into South Africa (Department of Trade
and Industry website 2004).
5.5.1. (a)
Manufacturing industry
Although South African economic activity can be categorically divided into majordivisions, divisions, and further sub-divided into major groups and subgroups, (or
alternatively into sectors and industries) the Department of Trade and Industry is
organized to attend mostly to the needs of the manufacturing industry.
Motor Industry (regulated by the DTI'
s Directorate: Motor Assembly and
Components) has benefited significantly from international competition and
accordingly has been one of the largest recipients of foreign investment of any
manufacturing sector since April 1994. Measures taken by the Directorate to
increase competition in this industry include a gradual reduction in tariff
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protection and the abolition of local content requirements. At the same time, the
directorate introduced a range of incentives for both domestic and foreign
investors that are designed to upgrade the capacity of the industry in all spheres
(DTI Annual Report 1996-7:48-54).
5.5.1. (b)
External trade and investment relations
Although there is not yet in place a multilateral system for the promotion and
protection of foreign direct investment, South Africa does have a number of
bilateral agreements entered into by the Department of Trade and Industry and
foreign partner governments.
Bilateral Investment and Protection (BIP)
agreements generally stipulate that, inter alia, investors should receive national
or most favored nation treatment, that investors or investments will not be treated
in a discriminatory manner and they will receive fair, equitable and just treatment.
While investments may be expropriated (normally only for a public purpose) such
action gives rise to the right of market related compensation which shall be
prompt, adequate and effective. The agreements also guarantee the right to
transfer of profits and remittances and other transfers related to investments,
including the repatriation of investments themselves. By 1997, South Africa was
in the process of negotiating BITs with over 20 other countries and had signed
BITs with Austria, Canada, Cuba, Denmark, France, Germany, Netherlands,
South Korea, Switzerland and the United Kingdom (Annual Report - Department
of Trade and Industry 1996-7:100 -102). By March 1999, 28 bilateral investment
treaties had been entered into by South Africa (South Africa Yearbook
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5.5.1. (c )
Company Registrars Office
The Company Registrars Office exists as a chief-directorate within the
Department of Trade and Industry and is responsible for the provision of efficient
and speedy companies registration services to both domestic and foreign
businesses (DTI Annual Report 1996-7:109). These registrations are governed
under the legislation encapsulated in the Companies Act 61 of 1973, the
requirements of which do not differentiate, to a significant degree, between
foreign and local investors in terms of establishing a business enterprise in the
country. The following specific references to foreign investors can, however, be
Chapter XIII (ss 322-336) of the Act requires that external (foreign)
must, within twenty-one days after establishment of the
place of business in the Republic, lodge with the Registrar a certified
copy of its Memorandum and Articles of Association, a list of the
names and addresses of the directors, and the names and addresses
of one or more persons resident in the Republic and authorized to
accept service of process and notices on behalf of the company. The
Registrar must be advised of any alteration in the names and
addresses of these persons.
Every external company shall appoint and shall at all times have an
auditor within the meaning of this Act and shall not later than fourteen
days after such appointment or any change in office of the auditor,
lodge with the Registrar in the prescribed form a notice stating the
name and address of such auditor or the change in such office.
Lastly, an external company must lodge with the Registrar annual
accounting records.
Importantly, the Act requires that the Registrar, upon receiving payment of the
prescribed registration fee, ‘shall register the said memorandum in the register
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kept by him under section 5, distinguishing the registration from the registrations
in respect of companies incorporated in the Republic’.
This is an important
requirement and can be taken as a first and important step in the process of
MNE regulation as it assists in distinguishing foreign from domestic firms, thus
facilitating the processes of promoting, monitoring, and controlling foreign
investment in the country.
By 1999, the Registrars office was concerned solely with the task of registering
and licensing businesses, and the financial data they required to accomplish this
task was not being captured or made available to other government departments
or agencies (Interview with Deputy Director- Company Registrars Office- April
1999)(DTI Annual Report 1996-7:108-9). This deficiency in record keeping and
information sharing was indicative of both a lack of appropriate information
systems and administrative coordination between government departments.
These deficiencies have been identified and are currently being addressed by the
Registrars Office.
5.5.1.(d) Department of Trade and Industry - Directorate: Technology Promotion
The Directorate: Technology Promotion in the Department of Trade and Industry
is responsible for overseeing the provisions of The Inventions Development Act,
1962 (Act No 31 of 1962) which calls for "the promotion of and development and
exploitation in the public interest of certain discoveries, inventions and
improvements and to establish a South African Inventions Development
Corporation and to prescribe its powers and functions and the manner in which it
shall be managed and controlled" (DTI website: www.thedti.gov.za).
Directorate is also responsible for administering the Technology Transfer
Guarantee Fund, the aim of which is to make local and international technology
available to South African Small Medium and Micro Enterprises (SMMEs), (DTI
website: www.thedti.gov.za). With respect to foreign direct investment, it can
thus be observed that the Directorate: Technology Promotion is the Governments
University of Pretoria etd – Moeti, K B (2005)
main institutional role player with respect to the execution of technology transfer
policy. It can further be observed that the policy approach of the government in
this regard, is one of support and facilitation rather than of control through, for
example, a body of technology transfer laws that places restrictive and local
participative requirements on potential investors.
5.5.2 Competition Commission
The Competition Act, 1998 (Act 89 of 1998) provides for the establishment of a
Competition Commission consisting of an Inspectorate and an Adjudicating
Body. Although the Competition Commission is an independent advisory body
that is attached to the Ministry of Trade and Industry, its decisions may be
appealed to the Competition Tribunal and the Competition Appeal Court (South
Africa Yearbook 1999: 285).
The functions and duties of the Competition Commission are specified by Section
21 of the Competition Act. These functions and duties include investigating anticompetitive conduct in contravention of the Act; assessing the impact of mergers
and acquisitions on competition and taking appropriate action; monitoring
competitive levels and market transparency in the economy; identifying
impediments to competition and playing an advocacy role in addressing these
impediments (DTI website: www.thedti.gov.za).
While striving to meet these goals, the Competition Commission must also
balance these against the broader social and economic goals as outlined in the
Act, such as employment, international competitiveness, efficiency and
technology gains, as well as the development and promotion of small and
medium sized businesses and firms owned or controlled by historically
disadvantaged persons. The Competition Commission attempts to facilitate the
achievement of this wide array of goals by working collaboratively with other
regulatory authorities (DTI website: www.thedti.gov.za).
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Although competition policy normally does not distinguish between foreign and
domestic companies, large foreign investors who may be in a position to
dominate particular industries or markets (a dominant position, according to the
Act, is defined as a market share of 35 percent or more) are also subject to
1999:285)(Muchlinski 1995: chapter 11).
5.5.3 The South African Reserve Bank (SARB)
The South African Reserve bank is the central bank of South Africa, and as such
it is tasked primarily with “[protecting] the value of the currency in the interest of
balanced and sustainable economic growth in the Republic" (section 3 of the
South African Reserve Bank Act 90 of 1989; Cf. section 224 of the Constitution -
Act 108 of 1996). One of the key instruments historically used by the Bank
towards this end has been exchange control policy. Exchange controls focus on
controlling the flow of funds and capital assets into and out of the country in order
to stabilize and maintain sufficient levels of the country'
s gold and foreign
currency reserves (Mollentze 2000:38).
In 1961 the South African government introduced exchange controls for nonresidents only.
This policy initiative effectively created a dual exchange rate
system whereby certain foreign equity investments into South Africa were carried
out in financial rand, while all other transactions were conducted in commercial
rand. By 1971 the Reserve Bank had also implemented a policy of exchange
controls on South African residents.
The turnaround in the Governments reliance on strict exchange controls to
stabilize the value of the currency began to take place around the mid-80s,
corresponding with the recommendations of the De Kock Commission. In 1983
the financial rand (and thus the dual exchange system) was abolished. Further,
with the dismantling of the system of apartheid, South Africa'
s full participation in
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the global economy was welcomed by South Africa'
s trading partners (Mollentze
In order for South Africa to successfully integrate into the global
economy, South Africa had to open up its economy to both inward and outward
trade and foreign direct investment.
This global economic integration thus
required, among other, the gradual removal by South Africa of exchange controls
that served to hinder the cross-border flows of capital and goods (Quarterly
Bulletin – SARB – March 1999:40).
5.5.4 Department of Minerals and Energy
South Africa’s mining industry has, since its inception, been one of the key pillars
of the South African economy. By 1997 the industry accounted for approximately
10 percent of gross domestic fixed investment (GDFI) while sales of primary
minerals alone accounted for 40 percent of total export revenue. (South Africa
Yearbook 1999:97).
The government department that is responsible for
exercising executive and administrative control and regulation over the mining
industry is the Department of Minerals and Energy.
With regards to mining
policy, the primary objectives of the Department are to:
Promote exploration and investment leading to increased mining output
and employment;
Ensure security of tenure of mining rights;
Address past racial inequities by assisting those previously excluded from
participating in the mining industry to gain access to mineral rights;
Recognize the responsibility of the State as custodian of the nation’s
mineral rights; and
Take reasonable legislative and other measures, to foster conditions
conducive to mining which will enable entrepreneurs to gain access to
mineral rights on an equitable basis.
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Policy reforms undertaken by the department have been particularly influenced
by the regulatory proceedings occurring in the areas of labor legislation,
environmental legislation, and the international competition for inward direct
investment in the minerals sector from developed and developing countries
(Green Paper, 1998 - Mineral Policy for South Africa). In working through policy
reforms, the Department has identified the following factors for consideration
(Green Paper, 1998 - Mineral Policy for South Africa):
The South African mining industry, one of the country'
s few world-class
industries, has the capacity to continue to generate wealth and
employment opportunities on a large-scale.
Mining is an international business and South Africa has to compete
against developed and developing countries to attract both foreign and
local investment. However, many mining projects in South Africa have
tended to be unusually large and long term, requiring massive capital and
entailing a high degree of risk.
South Africa has an exceptional minerals endowment, and in several
major commodities has the potential to supply far more than the world
markets can consume.
As articulated in its macroeconomic strategy, Government has committed
itself to a continuing process of economic liberalization, thus strengthening
the competitive capacity of the economy, fiscal and tariff reform and
bureaucratic deregulation. These are essential steps towards enhancing
the country'
s competitiveness, attracting foreign direct and portfolio
investment and creating a climate conducive to business expansion. The
mining industry among others will benefit in the long term from these
By its very nature the mining industry has the potential to endanger human
health and safety as well as the physical environment.
It is the
responsibility of Government to establish a regulatory framework that
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minimizes such dangers without imposing excessive cost burdens on the
industry and thereby jeopardizing its economic viability.
Mineral rights policy is an important aspect of mining policy in general. South
Africa’s current system of mineral rights is a dual system that allows for the
ownership of mineral rights by the State as well as by private owners.
present governmental administration, however, is of the belief that it’s objectives
as set out above cannot be met under the present system. In place of the status
quo, the State has articulated the following sub-objectives in respect of mineral
rights (Green Paper, 1998 - Mineral Policy of South Africa):
Government recognizes the inherent constitutional constraints of
changing the current mineral rights system, but it does not accept
South Africa’s system of dual state and private ownership of mineral
Government’s long-term objective is for all mineral rights to vest in the
State-owned mineral rights will not be alienated;
Government will promote minerals development by applying the “use it
or lose it” principle; and
Government will take transfer of mineral rights in cases where a holder
of mineral rights cannot be readily traced or where mineral rights have
not been taken cession of and are still registered in the name of a
The Department’s policy towards foreign direct investment is further expressed in
tax legislation that is unique to the mining industry. The rationale for having a
specialized tax structure for the mining industry is based on the fact that (Green
Paper, 1998 - Minerals Policy for South Africa):
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a) the risk to reward ratio in exploration is high, and mining itself is attended
by a high degree of geological, project and market risks;
b) particularly in big-scale and deep-level operations large amounts of capital
are required. This capital is at high risk over a long period;
c) mining companies are usually required to provide their own infrastructures
because of the remote location of mining deposits;
d) mining involves the realization of a wasting asset and the mine has little or
no residual value.
Continuing investment is therefore necessary in
exploration, the acquisition of rights to mine and the development of new
mines. All these activities form an essential part of the mining business
e) taxes that increase mining costs have the effect of increasing the cut-off
grade of ore, thus reducing the life of a mine and sterilizing mineral assets.
It has therefore long been recognized that, in principle, mines should be
taxed on profit and not in a manner which increases costs;
f) In view of international competition for investment funds, the tax system
should be designed to assist in attracting and retaining investment in
South Africa;
Thus this is in line with the above-mentioned basis for mining taxation,
Government’s tax policies for the mining industry are aimed at (Green Paper,
1998 - Minerals Policy for South Africa):
ensuring that the tax regime will be consistent and stable and that the
aggregate rate of tax will be internationally competitive;
seeking, wherever possible, to minimize taxes which increase the costs of
mining; and
ensuring that the tax system does not inhibit mining but encourages the
efficient use of resources.
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Foreign investors thus find that South African mining policy seeks to offer
investors, in general, a cost effective investment option through a tax scheme
that is favorable to mineral prospecting and exploration. In terms of ownership,
however, investors are no longer assured of the right of ownership over mining
land nor the right to conduct mining operations on that land. These rights are to
be vested in the State.
Foreign investors will also find that they will be held to greater account for the
negative externalities of their activities in this sector.
However, although the
State is in the process of legislating remedial measures to be placed on mining
operators that require the recovery of the costs for environmental damage,
pollution, ecological degradation and/or harm to human health caused by such
operators, the Department spent R20 million during the 2002-2003 fiscal year on
the rehabilitation of abandoned mines. Of this amount, R17 million was spent on
rehabilitating asbestos mines alone (Mineral and Petroleum Resources
Development Bill 2002, section 42; Cf. Department of Minerals and Energy –
Annual Report 2002/3: p.14)
5.5.5 Department of Environmental Affairs and Tourism
The Department of Environmental Affairs and Tourism administers, among other
legislative Acts, the National Environmental Management Act (Act No. 107 of
1998). The Act recognizes, in it'
s preamble, that "…everyone has the right to
have the environment protected, for the benefit of present and future
generations, through reasonable legislative and other measures that - prevent
pollution and ecological degradation; promote conservation; and secure
ecologically sustainable development and use of natural resources while
promoting justifiable economic and social development."
According to this legislation (and the Bill of Rights of the Constitution, Act 108 of
1996), the people have the power to hold government accountable for abuses to
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the environment caused by government or any other transgressors as the
environment is considered (by government) to belong to all the people of the
country (White Paper - Environmental Management Policy for South Africa
1998:20). Thus, government'
s responsibilities with respect to the alienation of
public resources (such as renewable and non-renewable natural resources) are
to ensure that the people of the country are not substantially disenfranchised by
the unchecked transfer of ownership of land and other public resources to private
investors (White Paper - Environmental Management Policy for South Africa
1998:20). Further, section 28 of the Act places a duty of care and remedial
repair on those persons and/or organizations who cause environmental damage,
pollution or harm to human health.
These persons/organizations are also
responsible for the costs of further preventive measures to reduce the risks of reoccurrence of any of the aforementioned violations.
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Table 5.1
Summary of FDI related policies as per responsible institution
of Trade and Commission
and Energy
Minerals Environmental
Department of
being phased
to Power
and land
remedial costs
on on
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5.6 Alternative policy options reviewed
It is possible to compare ideological approaches and policies along the
continuum of liberal/non-interventionist to conservative/insular. Summarily, the
two extremes of this continuum can be depicted as in table 5.1.
Table 5.2
Liberal versus conservative policy options
Investment incentives
Screening laws
Lack of specialized controls over FDI
Indigenization laws
Export processing zones and related
policy enclaves
liberalization agreements
(Adapted from Dunning 1993:554-560 and Muchlinski 1995:172-3)
To have a basis of comparison for the liberal/interventionist approach to foreign
direct investment, the conservative/insular approach is discussed next in further
The former approach will not be discussed at this juncture as it has
already been covered under the foregoing subtopics of this chapter (Supra. Par.
Policies that fall under the conservative/insular approach are normally
undertaken at either the stage of entry of foreign direct investment into the
country (screening laws) or during the operational phase in which the
multinational enterprise is already established in the host country and will then
have operating, performance or other requirements imposed on it (Dunning
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1993:554-560)(Muchlinski 1995:172-3). Screening laws, and indigenization laws
are briefly explained hereunder.
Screening laws
Screening laws refer to the evaluation, case-by-case, of the suitability of inward
investment proposals in lieu of granting authorization for the investment to take
Screening laws are one of the most commonly used methods of
regulating foreign direct investment and have been used by countries that are
both liberal towards foreign direct investment as well as by countries that are not.
Countries of the former type welcome foreign investment but are also concerned
about the loss of national (economic, political and social) sovereignty or adverse
economic consequences that may accompany such investments under certain
circumstances, whereas countries of the latter type are ideologically bound to
limit inward direct investment for the sake of national sovereignty (Muchlinski
Screening laws often come with conditions attached.
conditions are usually in the form of performance requirements that aim to
ensure that the investor contributes positively to growth and development
through such performance related measures as minimum export requirements
and local content requirements in production processes (Muchlinski 1995:195;
Cf. Dunning 1993:559).
There is no institutional mechanism in place in the South African context to
impose screening laws. This is not necessarily a criticism as screening laws are
generally thought to inhibit the flow of inward direct investment and additionally,
South African policy tends to lean to the liberal side of the policy continuum
outlined in tables 5/2 and 5/1. Thus in maintaining consistency between (and
aligning) the ideological approach of government to the types of policy
instruments used, screening laws do not and should not feature in any proposed
rationalization effort.
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Indigenization laws
Indigenization laws tend to have a converse relationship to laws that exercise
specialized controls over foreign direct investment and may appear in three
Firstly, and most commonly, are indigenization laws that place legal
restrictions on the percentage of ownership that can be held by foreign interests
in local companies. Secondly, there are indigenization laws that aim to give
citizens of host countries the opportunity to purchase shares in investing foreign
firms. It can therefore be seen that the rationale behind the first two types of
indigenization laws described above, is to increase the participation of host state
nationals in the economy. A third type of indigenization law is in the form of
restrictions on the participation of foreign investment in certain sectors of the host
states economy. This type of restriction is usually motivated by the perceived
need to protect, from foreign domination, industries that are relevant to national
security and defence, as well as industries that are considered to be culturally
significant (eg. media and broadcasting industries) (Muchlinski 1995:175-185; Cf.
Dunning 1993:559).
In the South African context, although there are no distinct indigenization laws in
place, certain culturally sensitive industries, such as the South African
Broadcasting Company are run as parastatal organizations under the direct
ownership and control of the government. Likewise Denel, the State’s defence
manufacturer is also a government parastatal, although it has recently been
partially privatized.
This being the case, the need for indiginization laws is
partially mitigated as long as foreign ownership and control of defence and
cultural industries is government controlled through other operational strategies.
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From the foregoing discussions of this chapter and particularly with respect to the
categorization of foreign direct investment policy approaches as depicted in
tables 5.1 and 5.2, it can be discerned that South African public policy vis-à-vis
foreign direct investment is formulated from a liberal approach that encourages
(rather than restricts) this type of investment. This being the case, there is little
evidence of specialized controls that restrict the entry of the foreign direct
investment of multinational enterprises. Rather, especially since the lifting of the
veil of apartheid, Government has put measures into place to encourage and
boost the levels of inward direct investment into the country as a means of
addressing the country'
s low savings and investment rates as well as to improve
the level of development of the country. Although these foreign direct investment
promotion measures were discussed in relative detail, it must be noted that the
specifics of the exact number, characteristics and qualifying conditions of
incentives and other promotional measures tend to change over time. Even so,
the general tone of the policy approach remains consistent over the long term.
The processes of establishing and operating a foreign business in South Africa
currently involves administrative oversight from more than one government
department. This is because the activities of foreign firms within the country are
expected to fall within the functional responsibilities of several departments. As
identified in this chapter, the most relevant departments in this regard are the
departments of Trade and Industry, Minerals and Energy, Environmental Affairs
and Tourism as well as the South African Reserve Bank.
There appears to be a high level of consistency across the South African public
sector in what is being articulated as the government'
s policy towards foreign
investors, however, there are issues of coordination that need to be addressed.
More specifically, the powers and functions of the minister of Minerals and
Energy, and those of the minister of Environmental Affairs and Tourism overlap
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in certain critical areas.
Thus, for example, The Minerals and Petroleum
Development Bill
Environmental Management Act of 1998 (Act No. 107 of 1998) both empower
their respective ministers to expropriate land and/or impose remedial costs for
damages caused by investors. Without the duty on the part of both ministers to
inform and cooperate with each other in these gray areas, loopholes in the
legislative framework may be created. Although it is possible that the current
South African Cabinet committee system may to some extent fulfill this
coordinating function, it can also be discerned that coordination needs to take
place not just at the Executive cabinet level.
Coordination of foreign direct
investment policies that are specific to the investment of multinational enterprises
must occur at all levels of policy analysis, policy drafting and implementation.
What may be needed is the creation of a coordinating body or institution that will
stay abreast of all policies and legislation applicable to foreign investors and will
thus be in a position to ensure a coordinated effort on the part of government
with respect to regulating investment (both domestic and foreign). With this in
mind, the next chapter addresses issues of coordination, rationalization and other
organizational dynamics.
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Chapter 6
Rationalization of Foreign Direct Investment Policy Structures in
the South African Government
6.1 Introduction
Extending the discussion of the previous chapter (Supra. chapter 5) where it was
shown that South Africa has no unit (department, directorate, sub-directorate or
advisory council) of government that is exclusively responsible for overseeing
and/or administering policy on the foreign direct investment of multinational
enterprises, the current chapter seeks to further explore the extent to which
foreign direct investment policy in the South African government may be
rendered ineffective given the highly fragmented and decentralized nature of
these policy dynamics. To this end, and against the backdrop that the central
objective of this study is to test the hypothesis – Ho = There is a necessity to
formalize a government administrative structure for policy setting and
implementation of Multinational enterprise (MNE) regulation in South Africa; if the
null hypothesis is not disproved this chapter aims to partially resolve this
hypothesis by assessing the prospects offered for remedial relief by the analytical
paradigms of organization theory with specific reference there under, to
rationalization or alternatively structural re-organization.
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6.2 Defining rationalization, organization and organization theory
6.2.1 Defining rationalization
Although the term rationalization is used with great frequency in the public
administration discipline, ironically, it is also a term that has received little
attention within the discipline in terms of being formally defined. As a starting
point for reconciling the way in which the term rationalization is to be used in this
thesis, reference is made to the definition offered by Banki (1981). Banki (1981)
very generally defines rationalization in the management context as “…referring
to the principles, methods and processes which are aimed at and utilized in
achieving, maintaining or increasing overall organizational or system efficiency.”
Thus, from Banki’s (1981) definition any management processes or activities that
are designed to increase overall organizational efficiency can be considered to
be part and parcel of the process of rationalization.
This definition of
rationalization is in-effectively broad and thusly does not make allowance for a
pragmatic application of the term.
Alternatively, Parsons (1995:15-6) discusses rationality, and thus by default
rationalization, under the auspices of policy-making stating that “…to have a
policy is to have rational reasons or arguments which contain both a claim to an
understanding of a problem and a solution.”
The implication being that to
rationalize is to develop and implement problem-solving policies that are based
on an assured understanding of both the problem at hand as well as its solutions.
Parsons (1995) further states that “…As Max Weber showed, the growth of
industrial civilization brought about a search for more rational forms of
organization for the state, commerce and industry.” Parsons (1995) definitions of
rationality and rationalization are far less general than those of Banki (1981).
University of Pretoria etd – Moeti, K B (2005)
Yet, while Parsons (1995) is theoretically complete in his definitions, these
definitions are not practically definitive in relating the types of problems and
solutions to be dealt with, nor the types of organizational restructuring implied
thereof. Roux et al. (1997:39) indirectly address these definitional shortcomings
by relating the term rationalization to the reduction in the number of South African
public executives institutions from the mid 1970s onwards that was based on
reducing redundancy through extensive analyses of the functions of all of the
various public executive institutions.
In order to give greater clarity of meaning to the context in which the term
rationalization is used in this text, it can be noted that although the terms
rationalization and re-organization are often used interchangeably in the
literature, there are slight nuances that can be asserted between the terms. In
this regard, the term rationalization is generally used to refer to streamlining by
departmentalization of related work activities (Roux et al. 1997:39-40; Cf. Bellone
1980:10-12), while re-organization, on the other hand, is used to refer to the
reconfiguration of existing institutional structures (e.g. structural changes to the
organization’s organogram) with the aim of seeking greater efficiency and
effectiveness in the carrying out of work related activities (Hogwood and Peters
1983;69-70; Cf. Chandler and Plano 1982:147-8; Cf. Gortner et al. 1987:chapter
4). Based mainly on the lack of specificity in differentiating these two terms in the
literature and in an attempt to take as broad and holistic an approach as
possible, for the purposes set forth in the problem statement, hypothesis and
objectives of this dissertation, the two terms shall herewith be used
Thus, rationalization is taken here to refer not only to
reductionism in government, but also refers to re-configurations of organizational
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6.2.2 Defining organization and organization theory
Although the literature suggests that there is no authoritative definition of the
term organization, this same prose simultaneously stresses that it is imperative
that a general understanding of the term be posited prior to discussion of the
broader concept of organization theory (Meyer 1985: 58; Cf. Roux et al. 1997:7-
8). Generally and very vaguely, the term organization is applicable to every
aspect of human interaction wherein a large and/or complex task is tackled by a
group of persons working in concert rather than by a single individual working
alone (Meyer 1985:58; Cf. Farazmand ed. 1994:55). Defining organization in this
way, it can be ascertained that organization is by no means a modern concept.
Even the most ancient and primitive of men were able to organize themselves for
the betterment of their collective social groupings (Roux et al. 1997:3-4).
Organization theory, in contrast, seeks to explain the formation, functioning and
termination of organizations. In it’s most elemental interpretation, and focusing
on its functional and operational implications, organization theory can be thought
of as that branch of the social sciences that is fundamentally concerned with the
efficient performance of the organization in as far as performance is dependent
upon the internal and external structural relationships of the organization. Thus
organization theory focuses internally mostly on the hierarchical relations within
the organization, and externally on the influence that the environment external to
the organization may exert on the organization (Meyer 1985:43-6; Cf. Roux et al
Organization and/or organization theory can further be understood within the
contextual frameworks of both public policy making and public administration. In
respect of the former, the public policy cycle can be described as the stages
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through which any public policy must progress in order to become operational
and organizing is a key component in this progression. In general, the policy
cycle would normally include the following stages (Hogwood and Peters 1983:8):
(a) Agenda-setting – in which problems existing in the society are perceived
as requiring some actions by government to correct them, and those
problems are moved on to some sort of official agenda for resolution;
(b) Policy formulation – in which the policy instruments which will be used to
attempt to alleviate the difficulties perceived in the environment are
(c) Legitimation – in which the policy instruments are accorded the authority
of the state, through some form of official action. This action may be
legislative, regulatory, or popular, for example, initiatives or referenda;
(d) Organization – in which some organizational structures are developed to
administer the policy. This may, of course, simply involve assigning the
policy to an existing organization rather than creating an entirely new
(e) Implementation – in which the administrative structures attempt to make
the policy work in practice;
(f) Evaluation – in which the outputs and consequences of the outputs are
analyzed and assessed according to some criteria; and
(g) Termination – various procedures have been developed to make
organizations and other policymaking bodies consider termination of
organizations and functions more often than they might otherwise.
In the policy making cycle, therefore, it can be argued that the best made policies
will not be implemented properly where the suitability of the organization
structure has not been examined. The importance of organization in the policy
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making process thus relates to the manner in which it provides the appropriate
mechanisms through which efficient service delivery can take place.
From a public administration perspective, organization can also be defined as
one of the key generic administrative functions of public managers (Roux et al.
1997:8-11). These generic functions can be summarized as follows:
policy making;
determination of work procedures; and
Although organizing is claimed by both the political science (public policy making)
and public administration fields of study as belonging to their particular genus,
the mechanisms of the process of organizing remain the same regardless of the
paradigm that claims ownership of it. Somewhat over-simplistically, under either
paradigmatic discourse, organizing roughly entails the arrangement of work
activities and the development of the hierarchical structures within which this
work is to take place. Thus once policies are put in place in the policy making
process or plans are finalized and readied for implementation in the public
administration field, the next step is to ensure that the most optimal
organizational structure for carrying out those polices and plans are in place (or
One of the most comprehensive and eclectic definitions of organization is that
proposed by Meyer (1985).
Meyer (1985:57-60) contends that almost every
definition of organization contains some or all of the following five elements (to a
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greater or lesser degree) – identity, purpose, structure, boundaries, and
interchange with environments. More specifically, identity is associated with the
name given to an organization.
The name of an organization helps to
differentiate it from all other organizations as well as providing information
(among other) about the organizations mission, goals, output and ownership. As
the second defining element of organization, purpose is what makes formal
organizations differ from informal organizations. Purpose being here defined as
- reasonably well defined tasks and the attendant accountability for carrying out
those tasks. Structure, the third defining element of organization, is present in
most formal organizations and is the element that makes it possible to break
complex tasks into smaller and more manageable ones through such
mechanisms as specialization and delegation.
Boundaries is yet a fourth
defining characteristic of organization, as it is important for defining the
organization’s internal and external environments in terms of certifying who may
or may not constitute the organization’s membership. Boundaries are far more
clearly defined for formal organizations than for informal groupings of people.
Lastly, the organization’s interchange with the environment refers to the process
by which inputs are acquired from the environment and outputs flow from the
organization to the environment. While the organization’s existence depends on
the cyclical flow of this interchange with the environment, the same is not
necessarily true of informal group structures.
In the sub-sections that follow, the overarching attempt is focused on gaining a
meaningful understanding of contemporary organizations with particular attention
being paid to seeking direction on identifying the fundamental issues associated
with efficiently and effectively establishing new organizational units or
alternatively re-structuring existing organizational units to accommodate new
policy initiatives. This mostly academic exercise begins with an exposition of the
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evolvement of classical and neo-classical organization theory to it’s current
contemporary state and ends with an exploratory comparison of contemporary
divergent thinking on organizations. To this we now turn.
Evolvement of organization theory
Mapping out the development of organization theory chronologically, three
distinct yet partially overlapping schools of thought can be identified – these are
the classical, neo-classical and contemporary organizational perspectives (Roux
et al. 1997:chapter 2; Cf. Farazmand 1994:chapter 1; Cf. Kramer 1981:chapter
4). Each of these is discussed in turn hereunder.
6.3.1. Classical organization theory
Common usage of the term bureaucracy has over the years become
synonymous with the term organization generally, and more specifically it
describes a distinct type of public organization.
That is, bureaucracy is
commonly understood to refer to public organizations in which power resides in
the hands of public officials rather than with politicians or citizens and voters
Cf. Weiss
and Barton
bureaucracies are also commonly associated with organizations plagued by
inflexible rules of operation (Weiss and Barton ed. 1980:7). One of the earliest
recordings of the usage of the term bureaucracy dates back to 1745 and is
attributed to Vincent de Gournay, a French Physicist and philosopher (Kramer
1981:83). Since then the term has been further popularized in the eighteenth
and nineteenth centuries and especially so in the early 20th century in the works
of Max Weber. The contemporaries of Weber during this time were Frederick W.
Taylor, Luther Gulick, and Henri Fayol. In fact, the publications of these four
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notable contributors to the discipline of formal organization studies are normally
classified together under the heading of classical organization theory
(Farazmand 1994:8-11; Cf. Roux et al. 1997:19-24). Roux et al. (1997:19) make
a further useful division of the school of classical organization theory into three
relatively distinct strains – i.e., the bureaucratic approach of Max Weber, the
scientific management approach of Frederick Taylor and the administrative
theories of Henri Fayol. Following along the lines of the analysis of classical
organization theory made by Roux et al. (1997), the discussion that follows
reviews the bureaucratic approach, the scientific management approach and the
general administrative approach in turn.
6.3.1 (a)
The bureaucratic approach
In addition to Taylor, Gulick and Fayol, Karl Marx may also be considered as a
fifth notable contributor to classical organization theory by way of his propagation
of political, sociological and economic ideas that served as important
antecedents of the classical organization genre. Although the writings of Karl
Marx (1818-1883) cover a broad spectrum of academic disciplines, his
contributions to and influence in the area of organization studies relate to his
analysis of systems of government and how they may or may not empower or
support the relationship between labor and capital. Thus, for example, Marx
proposed that capitalist societies tend to subordinate the interests of labor to
those of capital (those who own and control the means of production). In this
regard, some of the areas covered in his works include scholarship on such
themes as hierarchy, power and authority, autonomy and freedom, and
contradictions and crises, all of which in turn relate directly to issues of efficient
and effective organization (Farazmand 1994:5-7).
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Amongst the classical organization theorists, Max Weber was arguably the most
influenced by the work of Karl Marx (Farazmand 1994:9; Cf. Kramer 1981:83-5).
In line with Marx’s thinking, Weber was also fundamentally concerned with “…the
relationships between power – the ability to make people do what they do not
ordinarily do – and authority – legitimate power”(Kramer 1981:83). Additionally,
Weber strongly believed that bureaucracy was the most efficient form of
organization. In fact he defined an ‘ideal type’ bureaucracy which possesses the
following characteristics (Roux et al. 1997:23; Cf. Farazmand 1994:9):
1. A well planned hierarchy with clearly defined areas of authority and
2. A clear division of work to make specialization of functions possible;
3. A system of rules and regulations depicting the rights and responsibilities
of the holders of positions, as well as a system of well-prepared
procedures pertaining to the way in which the work and functions have to
be performed;
4. A system of strict and systematic discipline and control within which the
workers have to operate;
5. Merit based recruitment and promotion; and
6. Maintenance of files and records for future administrative action
As with most other proponents of classical organization theory, Weber believed
that a highly structured and tightly controlled organization was the only type of
organization that could operate efficiently.
His ‘ideal type’ organization was
prescriptive rather than descriptive and as such was intended to serve as a
rational model to which organizations (public, private or other) were to aspire.
Although Weber’s ideal type model has been heavily criticized in recent times, it
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is still a model that is widely prescribed to in today’s modern organizations
(Farazmand 1981:9).
Weber’s model has been criticized for, amongst other, taking the organization’s
external environment as a given by assuming that greater internal efficiency is to
be accomplished through focusing exclusively on internal organization or reorganization (Farazmand 1981:8-9; Cf. Roux et al. 1997:24-5). Critics also argue
that Weber’s ideal type bureaucracy pays little attention to how organizational
efficiency can be enhanced through the acknowledgement and attempted
satisfaction of human needs and aspirations.
Further, it is also argued that
Weber’s approach leads to the build up of inflexible working arrangements by
promoting red tape and delays in decision making (Farazmand 1981:9; Cf.
Kramer 1981:87-8).
6.3.1 (b)
Scientific management
As a point of departure along the organization theory line of reasoning, Frederick
Taylor, Henry Gantt, Frank and Lillian Gilbreth, among others made up what
came to be popularly known as the scientific management school. The central
thesis underpinning this school of thought was the application of ‘the scientific
method’ to the management process in general and to organizational dynamics
in particular. Taylor’s work was directed towards low skilled workers/laborers
who occupied the bottom ranks of the organizational hierarchy. As a former
engineer, Taylor proposed that similar to the design concepts incorporated in the
production of factory machinery and equipment, human beings could also be
made to be more productive through motion studies. It was thought, by the
proponents of this school, that there was ‘one best way’ of doing any job. By
establishing and training workers in this ‘one best way’, workers would
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experience no wasted motion and effort, leading to greater productivity. Workers
were also to be paid by the job rather than per hour as a further incentive
towards greater output and productivity.
In terms of organizational dynamics, scientific management theorists believed
that tight control and close supervision of workers was necessary to ensure that
workers carried out their tasks according to strictly and scientifically established
This mode of control was to be provided through a top-down
authoritarian management approach that was mechanistic rather than organic, in
which decision making was centralized rather than de-centralized, with narrow
spans of control, inflexible chains of command and where work was
departmentalized according to functional specialization (Kramer 1981:88).
The academic criticisms leveled against scientific management echo a similar
resonance to that contained in the criticisms made against Max Weber’s ideal
bureaucracy. That is, the failure to recognize the effects of environmental and
human relation forces on organizational efficiency made these models
incomplete, unrealistic and unworkable. Despite these criticisms, the theory and
practice of scientific management has also been credited with a number of
significant contributions to modern living such as, for an example, the
arrangement and standardization of typewriter keys to facilitate high-speed and
efficient typing (Kramer 1981:89). Scientific management is also credited for
being the conceptual foundation upon which more modern theories of
organization are built (Roux et. al 1997:25).
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6.3.1 (c)
General Management Theory/Administrative Theories
As indicated above, classical organization theory was not confined to scientific
management alone, but instead contained within it a second major stream of
reasoning and theory that came to be known as the general management school
of thought.
Among the most prominent proponents of general management
theory are Henri Fayol, James Mooney, Alan Reilly, Luther Gulick and Lyndall
Urwick. Whilst scientific management focused attention on improving the work
output of blue collar workers at the bottom of the organizational hierarchy,
general management theorists focused on the supervisory and management
levels of the hierarchy paying particular attention to what managers had to do or
know in order to improve the organization’s performance. In addition to framing
elements of management – i.e. planning, organizing, supervision, coordination
and control, Fayol also proposed fourteen principles of management which are
(Roux et. al 1997:21):
distribution of work;
authority and responsibility;
the subordination of individual interests to the general interest of the
reasonable remuneration of personnel;
centralization of authority;
scalar hierarchical authority;
orderly hierarchical structure;
equality in treatment of personnel;
stable and guaranteed terms of service of personnel;
emphasis on individual initiative; and
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maintaining the esprit de corps.
As can be seen from the above, the general management approach closely
mirrors that of scientific management especially with respect to the stern belief in
centralization and control, whilst however, general management was aimed at
reforming management rather than blue collar workers/laborers. The work of
Gulick and Urwick is also placed within the academic scope of general
management theory. Gulick and Urwick’s principle contribution to the field is in
their taxonomic proposal of organizing principles that suggests that institutions
should be structured according to four basic criteria, namely (Roux et. al
1997:22; Cf. Kramer 1981:90-3):
according to objectives which need to be reached;
according to process or function to be performed;
according to the needs of the client to be served; and
according to the geographical area where the service is required.
Gulick and Urwick recommended that the above four issues be evaluated and
compared to determine the most effective way in which a particular organization
should be structured. Thus, for example, an organizational unit can choose to be
organized and divided into sub-units located in and serving several geographical
areas where the resources and capacity exists to duplicate facilities and services
to these several different areas, and where doing so would result in better service
to clients; the same organizational unit may rather choose to operate from one
central location in which defined objectives, functions, and types of clients are
serviced through appropriately defined and structured sub-units if the benefits of
doing so outweigh the costs. Although much of the work of Gulick and Urwick is
representative of an outdated mechanistic way of thinking, the above four
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principles have not been subjected to much criticism, perhaps owing to their
timeless utility.
Neo-classical organization theory
The neo-classical school of organization theory developed out of a perceived
need to address the shortcomings gleaned in the scientific management
approach of the classical school of organization. Originating largely out of the
pioneering work of Elton Mayo and Fritz Roethlisberger during the 1920s and
1930s, the neo-classical school particularly sought to draw the human factor into
organizational analysis, design and management (Roux et. al 1997:25-7; Cf.
Kramer 1981:97-8). Mayo and Roethlisberger of the Harvard Business School
designed and conducted experiments aimed at determining whether efficiency in
work tasks and productivity could be increased through improved work
Although their experiments initially focused on the relationship
between factory lighting and productivity, they did not manage to establish any
such relationship. Instead, they came to the conclusion that where productivity
increased it was not because of work conditions but rather because of the
attention paid to and the importance given to employees needs.
specifically, and rather ironically, the intermediate findings of the Hawthorne
experiments were that productivity increased whether factory lighting was
increased, decreased or kept the same. Further experimentation led Mayo and
Roethlisberger to conclude that productivity was primarily affected by the
awareness of experimental subjects to the fact that they were being observed.
This scientifically derived conundrum came to be popularly known as the
Hawthorne effect.
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In summary, the neo-classical school accepted the general propositions of
scientific management and administrative management, but only on condition
that they include the recognition of the human element in their analysis (Kramer
1981:101-3). Mayo and Roethisberger were supported in their neo-classicalist
reflections by amongst others, Abraham Maslow and Douglas McGregor.
As with other scholars labeled as organizational humanists, Abraham Maslow
approached issues of organization from the perspective of human psychological
and physiological needs. Maslow believed that organizational performance was
ultimately dependent upon the satisfaction of the needs of the employees of the
organization. These basic human needs applied universally to all employees and
were arranged hierarchically as in figure 6.1 below. Higher order needs could
only be satisfied if the needs below them had also been met, and every person
aspired to reach the highest order need identified, i.e. - ‘self-actualization’. By
allowing employees to strive to attain their own personal needs and goals within
the organizational context, the organization would in fact be unleashing the
positive and often hidden potential of its employees towards the furtherance of
organizational performance (Kramer 1981:101-3; Cf. Golembiewski and Eddy
eds. 1978:210-211).
Figure 6.1: Maslow'
s Hierarchy of Needs
5th - Self-realization
4 - Esteem, status
3rd - Socialization
- security
1 - basic physiological needs
Adapted from Kramer 1981:102
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Douglas McGregor, a second important exponent of neo-classical theory,
superimposed and analyzed Maslow’s hierarchy of needs against Taylor’s
‘efficient organization’ and Weber’s ‘ideal bureaucracy’.
More specifically,
McGregor hypothesized that ‘classical’ organizational structures were not
conducive to the promotion of the needs of individuals in the organization. In
making his case, McGregor identified two diametrically opposed organizational
types or structures – namely ‘Theory X’ and ‘Theory Y’ organizations.
Theory X organizations are characterized as being structured according to
classical organization principles and were defined as having the following general
properties (Kramer 1981:103):
1. Management is responsible for organizing the elements of productive
enterprise – money, materials, equipment, people – in the interest of
economic ends;
2. With respect to people, this is a process of directing their efforts,
motivating them, controlling their actions, modifying their behavior to fit
the needs of the organization; and
3. Without this active intervention by management, people would be passive
– even resistant – to organizational needs.
They must therefore be
persuaded, rewarded, punished, controlled – their activities must be
This is management’s task – in managing subordinate
managers or workers.
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Further, the underlying assumptions upon which Theory X-type organizations
were created include the following (Kramer 1981:104):
1. The average man is by nature indolent – he works as little as possible;
2. He lacks ambition, dislikes responsibility, prefers to be led;
3. He is inherently self-centered, indifferent to organizational needs;
4. He is by nature, resistant to change; and
5. He is gullible, not very bright, the ready dupe of the charlatan and the
McGregror and other organizational humanists rejected this view of human
nature and human behavior, attributing the Theory X mindset to classical
organization theorists. Instead, McGregor subscribed to what he termed Theory
Y thinking which he defined as harvesting directly opposing views to Theory X.
Under Theory Y, employees are not considered lazy, but if they are found to be
so, it is the organizational structure that is to be blamed rather than the
employees themselves. That is, Theory X-type organizations create barriers for
employees to advance up Maslow’s hierarchy of needs. The lack of personal
fulfillment experienced by employees would then lead to the dysfunctional
behaviors indicated above. Thus, under Theory Y (Kramer 1981:105):
1. Management is responsible for organizing the elements of productive
enterprise – money, materials, equipment, people – in the interest of
economic ends;
2. People are not by nature passive or resistant to organizational needs.
They have become so as a result of experience in organizations;
3. The motivation, the potential for development, the capacity for assuming
responsibility, the readiness to direct behavior toward organizational goals
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are all present in people. Management does not put them there. It is a
responsibility of management to make it possible for people to recognize
and develop these human characteristics for themselves; and
4. The essential task of management is to arrange organizational conditions
and methods of operation so that people can achieve their own goals best
by directing their own efforts toward organizational objectives.
McGregor’s Theory X- Theory Y formulation is heavily biased towards Theory Ytype organizations. McGregor, therefore, was one dimensional and unrealistic in
his thinking on organizations, as no one system or model can work in every given
situation. More specifically, neo-classical organization theory is as incomplete in
it’s rationalizations as it’s predecessor (classical organization theory) in that it
favors one set of guiding principles over any other without taking account of any
possible contribution(s) to be made by opposing views.
Further research
indicates that the Theory X paradigm is most effective in situations where the
organization is faced with a stable external environment and has a task
environment that is relatively routine, and the Theory Y-type paradigm is better
suited to highly unstable and unpredictable external environments in which
organizational survival depends on navigation through a highly innovative task
environment (Kramer 1981:105-6). The openness to the possible contributions
of a number of alternative organization theories is representative of the most
recent thinking on organizations and is normally referred to as contemporary
organization theory the discussion of which follows forthwith.
Contemporary Organization Theory
The more current theories of organization, contemporary organization theories,
are based upon contingency and systems approaches. Contemporary writers do
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not discard, at least in whole, the foundational elements of the classical and neoclassical schools of thought. Instead, contemporary models incorporate these
elements and build upon them by taking account of the organization’s external
environment. To this end, contemporary organization theory rests on three key
tenets that relate specifically to the environment, namely (Roux et. al 1997:28-33;
see also figure 6.2 Infra.):
1. Taking account of the environment within which the organization
operates, and thusly assuming that the organization is an open system
that is affected by external forces;
2. Acknowledging that as an open system, the organization perpetuates it’s
survival by taking inputs from the external environment, processing these
inputs internally, and producing an output that flows back out to the
external environment; and
3. Acknowledgement of the fact that differing external environmental
conditions will require contingent approaches with regards to organization
theory, planning, and action.
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Figure 6.2: A simple open system
conversion of inputs
to outputs
Adapted from Roux et al. (1997:30)
At least one strong criticism can be made against contemporary theory. That
being the lack of distinction made between public and private sector
organizations. Public and private sector organizations have greatly divergent
objective and task sets and face very different environmental forces. As a result,
there is considerable room for the development of a sector specific approach to
contemporary systems analysis and organizational structural design.
Optimum hierarchical structure recommended
From the foregoing discussions on the several and chronologically arranged
theoretical bases of organization theory, it may correctly be discerned that in
today’s fast paced, competitive and dynamic environment, the most appropriate
organizational theoretical analysis should follow along the lines of contemporary
organization theory as it is the only paradigm to date in which environmental
forces are taken account of. By the same token, however, classical and neo-
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classical theories are not to be discounted as their principles are foundational to
those of contemporary theory and may actually work out to be more efficient for
organizations that face relatively stable and predictable external environments
(Meyer 1985:49-51; Cf. Roux et. al 1997:32-3).
The structural design options available for organizing include, among others, the
traditional forms of line; line and staff; functional and committee structures
(Hodgson 1969:34-40). Large and modern organizations, such as those tasked
with carrying out public policy in the public domain, incorporate elements of all
four of these traditional forms in what is commonly referred to as a pyramidal
structure (Hodgson 1969:40-60). The shape that a pyramidal structure tends to
conform to is a function of, among other, the number of levels of authority; span
of control specified for each authoritative position; and the degree to which
decision making has been decentralized (Hodgson 1969:40-60; Cf. Roux et al.
In organizing, it may also be necessary to expand the focus of the organizing
effort beyond the confines of the pyramidal structure defined. In other words, it is
necessary to specify whether departmentalization will take place within the
pyramid, or whether it must take place geographically (Hodgson 1969:40-60; Cf.
Gortner et al. 1987:107-110). Where the geographical spread of clients is broad
– creation, separation and distinction is required between a central office and
those of geographically spread branch (regional, local etc.) offices vis-à-vis their
differing objectives and responsibilities.
It is here recommended that for the case under study, the appropriate
organizational structure within which foreign direct investment policies should be
maintained should generally aim to be more mechanistic than organic as there
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needs to be a comfortable level of stability in the policies to which investors,
foreign and domestic, will be subjected.
Also, departmentalization based on
specialization is required given the degree of complexity and diversity of the
domestic industrial sectors within which investment takes place. Specialization
of departments is further supported by the fact that the proposed organization
needs to have a broad scope of knowledge and expertise in such diverse fields
as sustainable development, competition policy, and technology transfer.
Additionally, geographical departmentalization may also be required if regulatory
monitoring and control of investment strategies and activities is determined to be
a high priority activity of the proposed organization. In terms of determining
specific functions to be departmentalized geographically, the benefits of some
functions such as registration and filing must be weighed against the costs
involved in duplicating such functions across the country, especially in light of the
fact that it should be relatively feasible for potential investors to correspond with a
single centralized office.
Simultaneously, sensitivity to environmental forces may demand a more
contemporary approach to various other organizational dynamics. For instance,
the installation of performance management systems throughout the public
sector requires a management by objectives approach to goal setting and
performance monitoring thereby requiring lower levels of formalization and
control. International environmental forces may also impose pressures on the
proposed institution’s regulatory framework thusly requiring the organization to
be more flexible and organic in scanning the environment through its research
functions and in the policy-making domain.
Although it is envisioned that the
institution is expected to play a largely regulatory role, sector and industry
specific policy can also be expected to be generated from proposals to the
legislature coming from the proposed organization. It is further recommended
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that the establishment of the proposed organization be in the form of an
independent institution that is part of government but separate from all other
governmental departments. This is to ensure a more effective coordination role
as well as to ensure that the institution can act without pressures of fear, favor
and undue influence.
The commonality shared by all of the above theoretical approaches to structuring
organizations is the attempt to provide answers as to how organizational
performance can be assured and/or improved. In fact, it is commonly argued by
organization theorists that “…the choice of a particular form of organizational
change should clearly turn on some estimate of its probable costs and benefits”
(Szanton 1981:10). To this end, organization theories are supported by other
epistemological efforts that seek to quantify and measure the performance of
public organizations. Thus, discussion of the measurement of the performance
of public organizations and the implications this may have for organization
structure follows.
Measurement of Organizational Performance and Structure
One approach to assessing the performance of public organizations is through
the analysis of the programs and projects that these organizations may
undertake as part of their functional responsibilities.
Thus, given that
organizations and their sub-structures come into existence to meet specified
goals they must therefore be continually evaluated to measure their effectiveness
in meeting these goals. The outcome of such evaluation may result in either a
change in the goals required of the organization, change in the organization'
procedures and methods, or change in the organization by way of growth,
reorganization, or reduction. Thus, the importance of evaluation relates to its
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implications for structural and required change in organization. The processes
for conducting such evaluations in the public sector are addressed hereunder.
The discussion begins with a brief review of some of the major complexities
involved in public sector performance evaluation.
This is followed by a
discussion of the actual methods of evaluation for public projects and programs
[Internal rate of return (IRR), Net present value (NPV) and cost-benefit analysis
(CBA)] and the implications these may have for how organizations ought to be
structured. The approach to evaluation taken in the South African public sector
is also examined.
Public versus private sector program and project evaluation
Worldwide, there exists a strong current of opinion that private business operates
more efficiently than public organizations as can be deduced from the
culmination of the overwhelmingly international trend towards privatization. This
public mind-set can be traced back to the earliest branching off within the field of
accounting to form government accounting/public accounting (Meyer and
Webster 1985:26-28).
In the United States (circa early1950s), for example, not only was there a drive
within management circles in government to emulate operating practices
employed in the private sector, but additionally the accounting practices of
private industry were seen as an important tool for improved performance via the
evaluation feedback loop. That is, public accounting moved beyond complete
dependence on control through budgeting to adopt from private accounting such
key changes in principles as the change from cash basis to accrual basis
accounting for operational and reporting purposes (Meyer 1985:26- 28).
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Unfortunately, this view of improving performance and efficiency in the public
sector overlooked the fact that any activity, be it private or public has effects
beyond those intended. As an imperative, these external effects must be taken
account of if the objective is to make evaluation as complete, accurate,
meaningful and useful as possible. Thus, when formulating an opinion on the
performance of an organization (public or private) precaution must be taken such
that one’s view should not be limited to quantitative considerations of revenues
and expenditures whilst overlooking the objectives of the organization and the
outcomes of the organizations activities both quantitative and qualitative. As will
become apparent from the discussion that follows, this is especially critical for
public sector organizations.
Complexities of public sector evaluation
Szanton (1981:18) makes the point that “…the truth that structural reorganization
is painful, costly, and uncertain in outcome argues that it should not be
undertaken until the evidence is clear that current structures are inadequate and
that the changes proposed will actually improve matters”. The clarity of this point
is underscored by the complexity of the task(s) involved in assessing
administrative outputs and arriving at optimal solutions for actual or perceived
Three distinguishable and complicating features of evaluation of government
programs can be identified. First, is the problem of determining the appropriate
variables to use to represent such performance measures as benefits and costs
(or gains and losses). The benefits to consumers of the construction of a road
may include, for example, savings in the form of reduced costs for transported
goods; reduced travel costs due to savings in petrol consumption; and time
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saved as a result of reduced traffic. Determining and arraying these variables
can prove to be a time consuming and difficult task.
Incompatible with the Pareto standard of efficiency (the Pareto efficiency
standard defines as efficient that program or project that makes at least one
person better off whilst at the same time making no other person worse off), most
government programs affect several groups of stakeholders at once, producing
gains for some and losses for others.
Thus, given that governments are
responsible to all of its citizens for their welfare and wellbeing, evaluation of
government programs should include the benefits and costs accruing to all these
For example, a government program may provide benefits to
consumers through lower costs for services, while causing losses for both
alternative suppliers of the service and taxpayers who finance the program. The
gains and losses for all three stakeholders must be included in assessing the
success of the program (Fisher 1988:26-7; Cf. Gramlich 1981:44).
Second, another complicating factor is that many of the variables considered as
gains and losses are not easily quantifiable and thus measurable. In line with a
s obligations and commitments to its citizens, program benefits and
costs must be evaluated beyond profit maximization results and take account of
non-monetary variables such as pollution, health and safety, or even wastes of
s time. Changes in any of these accounts should be included in the
calculation (Gramlich 1981:4-5).
Third, the pricing of resources or benefits is more complicated for public than for
private enterprises.
Whereas private business evaluates benefits and costs
using market prices alone, governments may have to adjust market prices to
reflect social costs or benefits that are not captured in these prices (Gramlich
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1981:4). The prices that are adjusted to take account of such externalities are
known as shadow prices (Mishan 1976: chapters 13 and 14).
Methods of evaluation
The methods of evaluating the performance of government programs and
projects have long been a subject that has challenged researchers in the social
sciences. The approach taken by scholars of management and administration
tend to focus on the internal encumbrances to effective performance, such as
communication, compensation and motivation.
Examples of theories and
methods from this field include the goals approach, competing values approach
and participant satisfaction surveys (Rainey 1991:208-218).
In contrast, the standard method employed by economists (and consequently the
focal point of this section of the paper) in evaluating public and private programs
and projects is the cost-benefit analysis (CBA) method, the central criterion of
which is simply that the benefits of a program must outweigh its costs. Compared
to the general approach of management and administration scientists, the
economists'analysis has focused much more on the environment external to the
organization, taking as the key determinant of public performance the concept of
consumer surplus. Consumer surplus is basically a representation of the degree
to which program clients/consumers value program goods and services and can
be defined as the excess of the amount a consumer is willing to pay for a given
good or service over the amount actually paid (Mishan 1976:25) Graphically,
consumer surplus is an area under the demand curve that is specified by (or a
function of) the demand curve, price, quantity demanded, and marginal and
average costs (Mishan 1976:17-54)(Infra. Figure 6.3).
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University of Pretoria etd – Moeti, K B (2005)
measuring the consumer surplus of society as a whole. Indeed, it is important to
know how well the intended beneficiaries of a program are being served, but
since many of the costs for providing these services are borne by taxpayers (and
other citizens by way of external effects), the cost-benefit analysis must be
considered from the broader societal perspective. Thus the truism that no public
service can be provided “free” i.e. without cost to either taxpayers, the
consumers of the service, or society at large comes into play.
The demand curve for society then, can be represented as the cumulative
demand of all of society for that specific government program as determined by
the median-voter (the median vote is that choice that lies in the middle of all
available choices such that half the choices are below and half the choices are
above the outcome of the vote; see also Fisher 1988:53). With this demand
curve specified, figure 6.3 shows that at a given quantity (q) of service desired by
society, the price (p) is the price level at which government will provide the
Total expenditure of society is simply price times quantity which is
graphically equivalent to the vector op times the vector oq, and thus also
equivalent geometrically to the area oprq. The area qodr represents total gain to
consumers at quantity (q). Subtracting program expenditure oprq from total gain
to consumers qodr leaves the area pdr which is defined as consumer surplus
(Mishan 1976:27; Cf. Gramlich 1981: 29). Consumer surplus, once determined,
must be included as a benefit in the cost-benefit analysis (Mishan 1976:27).
Prato (1998:127-8, 266-7) extends the considerations of cost-benefit analysis to
include the concept of Net Social Benefit (NSB)(Infra. Figure 6.5). As opposed to
the cost-benefit evaluations that take consumer surplus to be the most pertinent
(and in some cases the only) measure of social benefit, NSB includes the
benefits and costs of both producers and consumers. Given that NSB is the
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amount by which benefits exceed cost, Prato demonstrates that the entire area
under the demand curve up to point (q) comprises consumer and producer
benefit, and the entire area up to the same equilibrium point (q) under the supply
curve represents consumer and producer cost. Thus, subtracting the area under
the supply curve from the area under the demand curve specifies the area
considered NSB which is therefore equal to consumer surplus plus producer
Figure 6.5: Net social benefit of consumers and producers
(Adapted from Prato 1998:127, 269)
With respect to public sector evaluation, whether or not one chooses to think of
total social surplus to include producer surplus, depends on the evaluator’s
perception or treatment of the institution of government. For those who argue
that government constitutes the collective will of society and that costs incurred
by government are in actuality costs to taxpayers and citizens; to equate
government costs of providing public services with producer costs, would amount
to double-counting that which has already been estimated as consumer costs.
This conclusion is implied in Prato’s analysis as he limits his discussion to
producers and consumers only. This rationale would lead to the conclusion that
cost-benefit calculations should be limited to considering the gains and losses of
two sets of stake-holders only - either private producers and private consumers
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in the private sector, or government (as producer) and private consumers, or
government (as producer) and private producers (as the consumer).
A more complete and perhaps more legitimate cost-benefit comparison for public
sector evaluation would be to consider separately the gains and losses of
consumers, producers, and government as done by Harberger (cited in Haveman
& Margolis 1983:Chapter 5) in contrasting the evaluation methods of cost-benefit
analysis with the basic-needs approach. In Harberger’s analysis a government
subsidy simultaneously causes a loss for government and gains for both
producers and consumers, or a loss for government and neither producers nor
consumers gain.
From figure 6.6 (Infra.) below it can be seen that the interests of each of these
three stakeholders can be considered together graphically.
This graphical
presentation works well to elucidate cost-benefit results of changes along the
price axis. The total cost to government of the subsidy is given by the area
TRGF and the proportion of this subsidy that is a benefit to producers is given by
the area SRGE, while the benefit to consumers is depicted by SEFT.
Alternatively, the basic-needs approach considers the same problem but from the
vantage point of the quantity axis as shown in figure 6.7. Both approaches lead
to the same result in this simplified example.
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The advantage of the preceding graphical presentation of cost-benefit analysis is
that it simplifies and clarifies the concept of consumer surplus and its relationship
to its determining factors. However, the graphical analysis requires pragmatic
application. This would entail a three stage process of first identifying and listing
all benefits and costs, second, converting them to their present values, and third
to compare these by ratio or net benefit. The first two stages of the process will
be addressed here as they are the more important and complex as compared
with the final stage which simply requires a comparison of costs and benefits
either by subtracting the former from the latter or by taking the ratio of benefits to
Benefits and costs to include in cost-benefit analysis
Answering the question as to which costs and benefits must be included in costbenefit analysis requires a consideration of society'
s gains and losses in general
as well as requiring a definition of the relevant primary stakeholders to include in
the cost-benefit analysis analysis. Society may be defined differently for each
program under study based on how wide-ranging the effects of the program are
estimated to be (for further discussion on defining society in the cost-benefit
analysis context see Haveman and Margolis 1983:94). This being noted, it can
be considered, for example, whether a project to widen a road can be evaluated
in the same way as a program that provides welfare benefits to the elderly.
Government agencies, the programs they oversee and the services they provide
can best be understood and evaluated in terms of the following three basic
functions of government – allocative, distributive, and regulatory (Gramlich 1981:
35). The benefits and costs to be considered in each of these categories of
government activities are discussed in brief hereunder.
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6.4.4 (a)
Allocative expenditure programs
Allocative expenditure programs are those that simply allocate funds for the
provision of public services at the national and sub-national level such as national
defence, police services and fire protection. This category also includes physical
investment programs – which are those programs whose services involve the
provision of some capital construction such as infrastructure (roads, bridges, and
dams)(Fisher 1988; Cf. Gramlich1981). By their very nature physical investment
projects will undoubtedly effect change upon the environment and may thus
require a unique set of evaluation tools (within the cost-benefit model) manifestly
different from those required of other types of programs. An excellent example of
this is the environmental impact assessment required of most physical investment
projects. As in most developed and developing/emerging market economies, the
Constitution of the Republic of South Africa, Act 108 of 1996 (in the Bill of Rights)
supports and promotes legislation that ensures the prevention of pollution,
promotion of conservation, and the assurance that economic and social
development will not contravene ecological sustainability.
Further, a significant
yet recent piece of South Africa'
s legislation in this regard is the National
Environmental Management Act, 1998 (Act 107 of 1998) that as its basis requires
an Environmental Implementation and Management Plan of every national
department whose activities may impact on the physical environment.
Comparatively, evaluation of other allocative program categories such as those
listed above (police, fire and national defence) may require instead the inclusion
of such quantitative measures or statistics as number of reported cases and their
direction of growth or change (Cf. Fisher 1988:304).
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6.4.4 (b)
Distributive expenditure programs
Distributive expenditure programs refer to programs that attempt to change the
income distribution in society. These programs are usually carried out through
government’s taxing function, welfare programs and human investment
A progressive tax system that imposes a proportionately greater tax burden on
the richer members of society than on the poor can be thought of as being a
distributive program as it attempts to provide for a more equitable distribution of
society’s wealth. Welfare and Human investment programs also have as their
goal the redistribution of society’s wealth, but through different means.
Welfare and human investment programs can be considered more similar to
each other than they are different.
Perhaps the most significant difference
between the two is that the expected outcomes of welfare programs are less well
defined than those for human investment programs. Thus, welfare programs
generally have as their objective the provision of basic needs to those members
of society who are unable to ‘adequately’ sustain themselves.
A common
approach to evaluating the efficiency of welfare programs uses the measure
defined as the welfare ratio – which is a family’s total realized income (including
welfare benefits received) relative to its level of need (based on family size, age
and location) (Haveman & Margolis 1983:Chapter 9; Cf. Gramlich 1981:Chapter
7). When this ratio is found to be less than one, the family is determined to be in
poverty for that year. When the ratio is between 1.0 and 1.25, the family is
considered near poverty, and when the ratio is above 1.25, the family is
considered non-poor. Simply stated, the object of this approach is to balance redistributive gains to program recipients against losses incurred by program
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contributors. The question to be answered is – “by how much does society gain
in transferring income from contributing to recipient families?”(Gramlich & Wolkoff
cited in Haveman & Margolis 1983:187).
6.4.4 (c)
Human investment programs
Human investment programs, in comparison, also provide benefits directly to
citizens and include programs for the provision of public education, health, and
job training. What differentiates these programs from welfare programs is that
their outcome is expected to benefit society (in the long-run) to a greater extent
than welfare programs.
Thus educational attainment and job skills can be
defined as the appropriate benefits of such programs whilst costs would include
the costs to society of financing the programs (Gramlich 1981:160; Cf. Fisher
6.4.4 (d)
Regulatory programs
For the objectives and hypothesis defined for the current study, the appropriate
classification for the discussion of foreign direct investment policies would fall
under regulatory type programs.
Regulatory activities of government can be
simply thought of as government mandates placed on private sector enterprises
concerning what to do and what not to do (Gramlich 1981: 201). From a costbenefit framework of analysis these types of programs can be judged by
weighting the costs - compliance costs of private producers, and usually also
costs to consumers by way of higher costs and prices for the regulated goods with the benefits accruing to society at large of improved products (safer
products) or processes (ex. - cleaner environment).
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Time value considerations in cost-benefit analysis
Generally, program and project cash flows that are one year or less in duration
can be estimated using current prices.
However, for cash flows of longer
duration, the time value of money becomes a significant consideration given the
realities of inflation and interest rates. The value of a dollar received tomorrow is
worth less than a dollar received today and therefore (future) cash amounts must
enter into the analysis at their present values in order to facilitate meaningful
The standard way in which anticipated future cash amounts can be assigned a
current value is by use of an interest factor or discount rate that compensates the
investor for amongst other things time, inflation and risk. This discount rate, once
determined, is a cardinal concept and a key factor in performing a competent
benefit-cost analysis. The decision to accept or reject a project or the decision to
select the optimal project amongst two or more alternative projects is especially
sensitive with respect to the evaluation method applied and the magnitude of the
discount rate used.
The internal rate of return (IRR) and net present value (NPV) criteria are the two
most widely accepted approaches to using discounted cash flows in benefit-cost
evaluations. IRR and NPV are calculated using the following formulas:
t =0
Bt − Ct
(1 + r ) t
(2) IRR: 0 =
t =0
Bt − Ct
(1 + i ) t
where: t = each individual year of the project
T = number of years the project lasts
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Bt = total benefits in year t (or each year)
Ct = total cost in year t
r = discount rate in NPV formula
i = discount rate in IRR formula
As can be seen, these methods use essentially the same formula and differ only
with respect to how that formula is used.
The net present value approach [eq. (1)] requires estimates for benefits, costs,
and the discount rate. If the discount rate used results in a positive net benefit
(i.e. the present value of all benefits is greater than the present value of all
costs), the project can be considered an acceptable option. In contrast, using the
internal rate of return method requires estimating benefits and costs only, and the
discount rate is solved for (with equation 2) rather than estimated. The principle
here is to compute that rate of discount (known as the internal rate of return - or i
in equation 2.) that would at minimum equate the present value of all benefits to
all costs. This is done by setting PV = 0 and solving for i. By this criterion the
project has positive net benefits and should be accepted if i > r, where the
estimated r can be thought of as the opportunity cost of capital. Alternatively,
when faced with two or more projects and scarce resources, projects can be
arrayed according to the value of i where the optimal decision is to select the
project(s) with the highest i value(s).
It is generally accepted and can easily be shown that the net present value
method is the more consistent of the two investment decision criteria. While both
methods need to be used cautiously and with particular attention being paid to
potential pitfalls, the internal rate of return method has been shown to be
ineffective as a decision tool for a number of reasons including:
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1. The solution of the internal rate of return formula can result in two or more
discount rates. This mathematical contradiction is evident when costs occur
at more than one point during the life of the investment. This is because
solving for the unknown in the internal rate of return formulation is equivalent
to solving for the root or roots of a polynomial equation (Chaing 1984:17-53;
Cf. Mishan 1976:183-95). The following example given by Mishan (1976:1878) illustrates this anomaly:
An investment stream of - 100, 420, - 400 has two different rates of return,
46% and 174%, that solve the internal rate of return equation.
2. For investment projects whose benefits and costs expire within the period of
one year, the net present value method is acceptable because for
investments of this duration, the net present value of benefits over costs is
equal to the undiscounted net benefits. However, i in the internal rate of
return formula cannot be computed to give a meaningful measure (Gramlich
It is therefore advisable to use the net present value method for all cost-benefit
discounting calculations and decisions.
Appropriate discount rate
For public sector investments, before the translation of monetary benefits and
costs into equivalent and comparable present value figures, the issue of the
appropriate discount rate to be used – the unknown in the net present value
(NPV) formula – must be resolved. As yet, in the academic discourse on this
matter, there exists no firm consensus amongst the more prominent scholars.
Some even reversing or modifying their positions as the subject continues to be
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studied and debated (Gramlich 1981:96).
Essentially, the three competing
perspectives on determining the discount rate for public investments are the
gross before-tax rate of interest on private investment, the weighted average of
the gross before-tax rate of interest on private investment, and the after-tax rate
of return on private savings, and the social optimum rate of discount (Gramlich
1981:95). A brief discussion of each of these follows.
6.4.6 (a)
Gross before-tax rate of interest on private investment
The rationale for using the gross before-tax rate of interest on private investment
as the discount rate for public investments assumes an equivalence between the
two types of investments (public and private) before taxes such that investing in
one is an opportunity cost for not investing in the other.
The underlying
assumption is that because many governments exempt a substantial proportion
of their bond and security issues from taxes, a rational comparison of returns for
public and private investment can only be made on a pre-tax basis. However,
this construction overlooks the fact that private and public investments can never
be commensurate, as their corresponding discount rates must not just account
for tax differences but must also be adjusted to account for risk. As a result of
government regulation, investments above a particular level of risk are
unavailable for public investment thus resulting in a lower required rate of return
and discount rate for public investments (Prato 1998:266; Cf. Bradford cited in
Haveman & Margolis 1983: 130).
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6.4.6 (b)
Weighted average rate of return
This approach to determining the discount rate to be used for valuing public
investments is based on the premise that funds available for public investment
can be estimated as the opportunity cost of funds that would otherwise have
been used for private investment and/or private consumption. The opportunity
cost of the former is estimated as the before-tax return on private investment and
the opportunity cost of the latter is estimated as the after-tax return on consumer
saving. The rationale here is that the weighted average of these two opportunity
costs is the best estimate for the public investment discount rate.
s (1981) argument against the use of this weighted average method is
based primarily on the inclusion of the after-tax return on consumer saving.
When calculated using '
real'data, this rate quite often turns out to be negative
after adjusting for inflation and government regulation that puts a ceiling on the
amount of interest payable to consumers through bank savings accounts.
This after-tax rate cannot therefore be taken as the rate investors require to
invest their savings in public projects, but rather this rate reflects the constraints
imposed by government on consumer savings.
6.4.6 (c)
Social discount rate
It has been shown and it is generally accepted that the required rate of return on
government investments (i.e. the economy’s risk-free rate of return on
investment) is closely approximated by the long-run real growth rate of the
economy (Reilly 1985:10-19; Cf. Gramlich 1981:101-7).
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This derivation of the appropriate discount rate for evaluating public investments
is based on the premise that this is the optimal rate of discount that maximizes
return (or equivalently output) where this maximum return occurs at the highest
point on the production function. Gramlich (1981) shows that the slope of the
tangent to the production function at this point is equal to the slope of the capital
requirements curve which is in turn equal to the growth rate of the economy.
Cost-benefit adjustments
For government projects it is usually not possible to compare all benefits to all
costs as the cost-benefit method requires. In those cases where the benefits of a
project are not easily quantifiable, two alternatives to the cost-benefit analysis are
cost effectiveness evaluations and monetarizing costs and benefits.
6.4.7 (a)
Cost effectiveness
The cost effectiveness approach rests on the premise that where benefits are not
easily quantified it is feasible to compare alternative programs with the same
objectives based on costs alone. This method indirectly maximizes net benefit by
directly minimizing costs. "Benefit-cost analysis is really a framework for
organizing thoughts, for listing pros and cons, and for placing a value on each
consideration. In many situations there will be some considerations that cannot
easily be enumerated or valued and where the benefit-cost analysis becomes
somewhat more conjectural. Yet the sensible way to deal with such omitted
considerations is not to abandon all efforts to measure all benefits and costs, but
circumstances] … viewed in this light, even if benefit-cost analysis alone does
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not make any decisions, it can serve a valuable purpose in focusing decisions on
the critical elements" (Gramlich 1981:5).
6.4.7 (b)
Monetarizing costs and benefits
It is obviously not possible to assign a monetary value to each variable
considered relevant to a cost-benefit calculation.
Rather than attempting to
convert all direct and indirect benefits and costs into monetary terms, Prato
(1998:ch.12) suggests the utilization of multiple criterion decision analysis (Cf.
Gramlich 1981:5).
In short, this analytical approach accommodates the
combining of monetary and non-monetary cost-benefit assessments into a single
study by simply quantifying that which is quantifiable and listing and ranking
those variables than are non-quantifiable in monetary terms. This should result
in more accurate and meaningful impact measures than would be obtained by
assigning arbitrary and subjective monetary values to such factors as aesthetics.
Further, the temptation to exclude from the analysis one or more factors because
they cannot be monetarized, would lead to underestimation of costs or
overestimation of benefits.
Efficiency considerations in cost-benefit analysis
The decision by government to take on a project or to provide a service, is
motivated by efficiency concerns. That is, if inefficiency (in terms of price and/or
quantity) exists in the private market for the delivery of needed services to the
public, government is obliged to intervene in that market by providing the service
or product in question more affordably and efficiently than is currently the case.
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6.4.8 (a)
Pareto efficiency principle
Among the efficiency concepts that may be used in parallelism with a cost-benefit
analysis are the Pareto efficiency standard and the Kaldor-Hicks criterion
(Gramlich 1981:42). The Pareto standard defines efficiency as a state of affairs
in which it is not possible to make at least one person better off without making
someone else worse off (Fisher 1988:27; Cf. Gramlich 1981:42). The practicality
of this concept is questionable as it is rare to encounter a government program
that meets this standard (Gramlich 1981:42).
Rather the usefulness of this
theorem lies not in it’s stated requirement for bringing about or determining
efficiency, but in its implicit recognition of possible externalities of programs that
must be accounted for.
Kaldor-Hicks efficiency principle
The Kaldor-Hicks principle basically extends the rationale of Pareto efficiency by
defining as efficient government programs in which the gainers could
compensate the losers and still be better off. Stokey and Zeckhauser re-phrase
this principle in more pragmatic terms: “In any choice situation, select the (policy)
alternative that produces the greatest net benefit.”(cited in Gramlich 1981:43).
Here the combined financial gains and losses of all stakeholders are summed
together to derive the net benefit. This total is then compared to the total cost of
the program or project. The option with the highest benefit-to-cost ratio or net
benefit differential is to be selected (Gramlich 1981: 117).
Government programs that are concerned with distributive equity normally adjust
the Kaldor-Hicks cost-benefit measures by using a simple weighted average
technique that assigns greater consideration or weight to gains and losses of
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low-income or disadvantaged groups. Gramlich correctly cautions however, that
“… the distributional weighting of gains and losses is typically one of the most
speculative aspects of any evaluation” (Gramlich 1981:120).
Evaluation methods in the South African public service
Section 196 of Act 108 of 1996 assigns to the Public Service Commission (PSC)
the task of 'promoting effective and efficient public administration and a high
standard of professional ethics in the public service'. This is to be accomplished
through the evaluation and oversight functions of the Public Service Commission
as specified under sub-sections (4)(b) and (4)(c) which are:
(b) to investigate, monitor and evaluate the organization and administration, and
the personnel practices, of the public service; and
(c) to propose measures to ensure effective and efficient performance within the
public sector.
Although the Public Service Commission is essentially the government'
s policymaking body in the areas of public performance management, implementation of
these performance management mandates is carried out by the Department of
Public Service and Administration. A key initiative currently being carried out by
the Department is the implementation of Performance Agreements.
consultation (between managers and subordinates) is involved in effecting these
agreements and there exists a fair amount of flexibility in defining performance
measures. The scope of the agreements, however, is heavily weighted toward
internally focused measures.
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In addition to the mandate required of the Public Service Commission, the
responsibility for performance evaluation in the South African public service is
shared with the office of the Auditor General (AG). The Auditor General'
s office
fulfills it’s constitutional mandate to evaluate public sector performance through
its accounting and management auditing activities.
The work of the Auditor
General is therefore fundamentally centered in the discipline of public accounting
and is focused on the efficient, competent and honest use of public funds
(Annual Report of the Auditor General: 1997-8).
The observation is made here that the quantitative approach of the Auditor
s office needs to be increasingly tempered with qualitative performance
appraisal that is also externally focused.
To this end, the Department of
Education has positioned itself as a conspicuous example of the shifting
importance being given to externally focused program evaluation in the S.A.
Public Sector. Specifically, the review committee that studied the efficiency and
effectiveness of "Curriculum 2005" effectively balanced the 1997 Auditor
General’s audit of their department with qualitative assessments of the social
objectives and outcomes of one of the department’s most significant programs.
Summary – Measurement of performance and structure
The private sector enterprise is normally concerned primarily with maximizing
profits, however, in this era of social consciousness and corporate responsibility,
private enterprises are increasingly being forced to consider the externalities of
conducting business.
Conventionally, at least up until very recently, private
business compared or decided upon investments using capital budgeting
techniques which applied essentially the same benefit-cost analysis used in
evaluating public programs and projects. However, private sector cost-benefit
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analysis had been focused almost exclusively on monetary gains and losses and
excluded externalities in the calculation. In recent decades, this focus of analysis
has experienced a slow but steady paradigm shift brought on in many respects
by the constraints put upon private businesses by the legal environment in which
they operate and in which they are held responsible and accountable for their
actions. Further, private corporations are increasingly adopting the philosophy of
corporate responsibility not just for the sake of benevolence or legal sanction, but
good business practice and economic survival dictate these largely public
It is increasingly clear that the evaluation considerations for both private and
public investment are converging.
However, regardless of the degree of
conformity between these two types of evaluation, arguably there must always be
a higher moral standard placed on public enterprise investments as the private
enterprise will always possess an opportunistic self-interest epitomized in the
profit motive whereas the public sector will always be responsible - almost
paternalistically - for citizen welfare. Consequently, the scope of inclusion of
benefits, costs and externalities will always be broader for public investments
than for private enterprise investments.
An important caveat is that there can be no precise determination of net benefit
for public programs and projects.
Rather, it is only possible to arrive at
determinations given the nature of the problem of limiting the variables to be
included in the analysis (for example - plant life and endangered species) and
measuring them. However, despite the imprecise and subjective nature of costbenefit analysis it still remains a worthwhile effort as it at some level
substantiates the external implications of government activities when one
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considers the connectivity of relationships that exist in society in general as well
as between society’s members and the physical environment.
Regulation and Structure
In defining a social problem, Hoogerwerf (in Wittrock and Baehr (eds.) 1981)
states that “…a [social] problem exists if there is a discrepancy between a goal or
some criterion and the perception of an existing or expected situation.”
In the
case of the regulation of multinational enterprises therefore, in defining the
problem, or assessing, or justifying a policy (or set of policies) it is necessary to
start with a clear indication of the goals or expected benefits, if any, that the
government intends to derive from its relationship with multinational enterprises.
In turn, this can only take place in an organized manner wherein organizational
systems and structures are in place to oversee the administration of the thusly
concluded set of policies.
In order to give effect to, monitor and review policies decided upon, such policies
must be housed in the appropriate institution(s) of government. It is not enough
for government to espouse a general approach to foreign direct investment; it is
necessary to articulate the government’s policy formally and clearly within a
clearly defined administrative framework. This point is strongly emphasized by
Dunning (1993:566), for example, who states that “…the success of government
policy towards … inward direct investment depends upon the effectiveness of the
administrative machinery set up to implement and monitor the policies decided
upon.” Mhlanga (2003) is also of the opinion that social policies are sure to fail
where such policies are hurriedly set up and promulgated in countries that fail to
also establish the necessary institutional mechanisms to continuously monitor
and review said policies. It can further be argued by extrapolation, that countries
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that have neglected to centralize their foreign direct investment policy structures
inefficiency in
responsibilities and objectives of the several ministries involved in some manner
in the administration of this type of investment.
As an example, there may
emerge conflicting regulations coming simultaneously from a Ministry of Labor
and a Ministry of Science and Technology. This may occur where the former
Ministry is primarily concerned with attracting labor-intensive job creating
multinational enterprise investment, while at the same time the priorities of the
latter Ministry involve upgrading domestic technological and innovatory capacity,
an objective which may tend to reduce labor-intensive employment (Dunning
Developing a regulatory framework for the regulation of multinational
Academic inquiry and literature, of the 1950s and 1960s, aimed at investigating
the intrinsic nature and proliferation of multinational enterprises led to policy
assessment that in large part suggested tighter regulation of this type of business
enterprise. This shift of policy orientation was in large measure based upon
research findings that confirmed the ability of multinational enterprises to
transcend national regulatory boundaries, as well as confirming the potential for
monopoly control of markets by multinational enterprises.
The multinational
enterprise was thus seen to be a unique form of business enterprise that required
a specialized regulatory framework to control against its possible abuses of host
states (Muchlinski 1995:7). Since the 1960s, however, there have been several
additional major ideological influences on the regulation of multinational
enterprises. These ideological strands are the ‘neo-classical market analysis’ of
the multinational enterprise, the ‘orthodox post-war economic’ perspective, the
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‘Marxist’ perspective and the ‘nationalist’ perspective, and more recently the
‘environmental’ perspective and ‘global consumerism’ (Muchlinski 1995:90-101).
In order to present a balanced approach to understanding regulatory motivations
and current approaches to host state regulation of multinational enterprises,
these major ideological influences that have been shown to affect the extent and
nature of multinational enterprise regulation will be discussed hereunder.
6.5.1 (a)
Neo-classical market analysis
The underlying assumption of the neo-classical market perspective is based on
the laissez faire principle that the market operates most efficiently when left to its
own devices.
Therefore, this view purports a minimalist approach to
multinational enterprise regulation. The multinational enterprise is seen as a
crucial conduit for the proper development and advancement of the international
economy through its unique abilities to integrate and coordinate resource
allocation globally. As such, multinational enterprises can only fulfill this role if
they are uninhibited in the establishment and operation of affiliates wherever and
whenever needed.
The major criticism leveled against the neo-classical
perspective is that it fails to recognize that countries differ fundamentally and as
a result an ‘open door’ approach to multinational enterprise regulation will not
always result in an equal international spread of the benefits to be derived from
the foreign direct investment of multinational enterprises (Muchlinski 1995:93).
This concern is partly addressed in the ‘orthodox economic’ perspective on
multinational enterprise regulation which is discussed forthwith.
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6.5.1 (b)
The orthodox post-war economic perspective
Whereas the neo-classical perspective saw free and unregulated markets as the
path to global economic efficiency, the orthodox post-war approach argued that
without some amount of intervention markets can and do become imperfect
allocators of resources.
Large corporations (both domestic and foreign
multinational enterprises) were seen to have the ability to dominate and
monopolize markets thereby causing markets to function inefficiently. Orthodox
exponents suggested that such market failures could only be controlled for by the
use of selective public sector interventions.
The Orthodox approach does,
however, recognize the potential gains that may accrue to nation states from the
foreign direct investment activities of multinational enterprises and as such, this
approach sees over-restrictive controls as self defeating. In the final analysis,
the orthodox school takes a middle of the road approach tailored to specific
circumstances of nation states and multinational enterprises.
Examples of
diversity of regulations that fall under this perspective are the low intervention
approach of existing and draft voluntary international codes of conduct
concerning multinational enterprises and European Community proposals for
greater disclosure and accountability, and the high intervention approach
exemplified by national laws requiring indigenous involvement in the ownership
and control of local subsidiaries of foreign corporations (Muchlinski 1995:93-5).
6.5.1 (c)
The Marxist perspective
Based on the views and arguments of Karl Marx on the exploitation of labor by
capital, the Marxist perspective sees multinational enterprises as agents of
capital exporting countries that have the power to control both the flow of raw
materials and finished products in and out of less developed countries (LDCs) as
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a result of the multinational enterprises monopolistic control of the market(s)
concerned. According to this perspective, this exploitative relationship justified
excessive regulatory measures such as nationalization and expropriation
(Muchlinski 1995:95-7).
6.5.1 (d)
The Nationalist perspective
The ideological basis of the nationalist perspective on multinational enterprise
regulation takes expression, among other, in the pro-nationalist sentiments of
dependency theory'especially with respect to prioritizing national independence,
self-determination and cultural autonomy in relations with multinational
enterprises. In this regard, for example, large foreign firms are seen to be a
threat to the way of life of the people in the host country by way of displacing
cultural identity and adapting local consumer tastes to those of foreign origins
mainly by investing heavily in advertising. There is also a fear of interference in
the political sphere of the host country by multinational enterprises as had been
demonstrated in Chile and elsewhere (Supra. Sect. 4.2.2).
The more overzealous nationalistic approaches have been criticized for being
self-defeating as they may actually tend towards a greater degree of dependency
than that which they seek to avoid through nationalization and expropriation.
This is because they give preferentiality to the replacement of foreign
management corps and techniques with less efficient local substitutes
(Muchlinski 1995:97-9).
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6.5.1 (e)
The Environmental perspective
Environmental concerns are among the more contemporary issues that have
entered the debate on multinational enterprise regulation.
According to the
environmental perspective two important areas that need to be taken account of
in developing a regulatory framework for multinational enterprises are firstly,
environmental health and safety, and secondly, incidence of exploitation of
countries that are regarded as environmental pollution havens. With respect to
the former, environmentalists call for provision to be made for the development of
an international legal regulatory body on group liability for damage caused by
environmental hazards under the control of multinational enterprises, more
certain rules on the provision of compensation in the case of accidents, and
improved disclosure on health and safety issues. With regards to the latter, the
environmental approach calls for regional or preferably international coordination
and consensus on pollution standards (Muchlinski 1995:99-100).
6.5.1 (f)
Global consumerism
Although theorists of global consumerism accept that there are going to be social
and cultural changes brought on by the presence and activities of multinational
enterprises in host countries, they do not necessarily accept that these changes
should be considered in a negative light. Instead, they welcome the creation of a
new global culture and lifestyle perpetuated in large measure by transnational
media and advertising firms that aim to develop consumer tastes for the products
sold by multinational enterprises.
The drive to satisfy these new consumer
demands is expected to contribute to development as job creation and
increasingly higher standards of living will be have to be the economic and social
policies prioritized by host country governments (Muchlinski 1995:100-101).
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Normative jurisdictional levels of regulation
Against the backdrop of the varying beliefs about the extent to which
multinational enterprises should be regulated, each individual nation-state needs
to determine its own particular regulatory framework based on its predominating
political and ideological orientation towards the foreign direct investment activity
of multinational enterprises. To this end, optimization of a regulatory framework
for multinational enterprises requires going through a two-stage analytical
process that consists of firstly analyzing the substantive content of any regulatory
agenda that is currently in place, and secondly, evaluating these against the
normative jurisdictional levels and methods of regulation, as have commonly
been applied globally, so as to identify effective policy options that may be
available to policy makers (Muchlinski 1995:90). The first stage of this process,
i.e. analyzing substantive policy content, was covered in the previous chapter
(Supra. chapter 5) of this dissertation. With regard to the normative jurisdictional
levels and methods of regulation, host states can exercise regulation over
multinational enterprises through either the national, regional or international
levels. Each of these will be discussed in turn, hereunder.
6.5.2 (a)
National level of regulation
The national level of regulation can be subdivided into unilateral and bilateral
regulatory frameworks. The unilateral branch of the national level of regulation is
indicative of cases in which a host country acts alone in determining what
regulations will apply to multinational enterprises and foreign direct investment
with little or no concern for how these policies may affect the multinational
enterprise in question, the home county of the multinational enterprise in
question or any other incidental stakeholders. In contrast, the bilateral approach
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to regulation at the national level involves agreements between host and home
countries of multinational enterprises on issues of regulatory control. Here the
interests of the multinational enterprise, host country and home country are given
due consideration and compromise is reached between them in determining the
most appropriate regulatory policies (Dunning 1993:574-8; Cf. Muchlinski
Although the national level of regulation is the most common approach to
regulating multinational enterprises, it has been criticized for failing to provide
consistency in how multinational enterprises are to be regulated domestically as
well as in the international arena. That is, as the main aim of host government
regulation of multinational enterprises at the national level is to negotiate and
secure the greatest economic and social gains from the foreign direct investment
activities of multinational enterprises, this level of regulation may in principle and
theory lead to as many different regulatory regimes as there are countries in the
world. The problem that this circumstance creates for individual countries as well
as for the global economy at large is that multinational enterprises will be in
advantaged position to play one country against the other as countries compete
to attract foreign direct investment.
Such competition would prove to be an
inefficient use of resources such as investment incentives.
In terms of
consistency on the domestic front, too many regulatory agendas may develop as
these may evolve from bi-lateral (as opposed to regional or international)
negotiations and agreements between a particular host state and a number of
home states representing the interests of their multinational enterprises in the
host country. It can thus be concluded that bilateral treaties are limited in their
ability to provide the appropriate and efficient solution to regulatory problems
since they represent specific regimes applicable only to the signatory states of
those specific treaties.
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A further significant criticism of the national level approach is that it does not take
account of the mismatch that exists between the territorial and jurisdictional limits
of the laws of the regulating host state, and the global spread of the economic
interests and activities of multinational enterprises operating from within the host
s borders (Muchlinski 1995:107-111). As has been documented in Lubbe v.
Cape Plc and other cases (Supra. Sect. 4.3.2), this mismatch has tended to lead
to international legal complications for which most individual host governments
lack the legal capacity to resolve.
6.5.2 (b)
Regional level of regulation
The regional level of multinational enterprise regulation refers specifically to the
establishment of supranational regulatory policies as well as supranational
regulatory bodies to administer those policies. The coverage of that regulation
being greater than that of the bi-lateral form yet lesser than that of the
international form. In other words the geographic coverage of the regional level
of regulation is limited to groups of countries that share a distinct (and normally
contiguous) geographic area and who would benefit from the establishment of a
common market, currency and/or political system.
Regional regulation of multinational enterprises serves to address some of the
shortcomings identified in the national (unilateral and bilateral) approach. As
such, regional regulation has the potential to reduce the mismatch between the
territorial and jurisdictional reach of host states and the geographical scope of
multinational enterprise operations.
However, this is the case only for firms
operating exclusively within the territorial region of the participating states. With
respect to firms operating both within and outside the common region, the
problem of jurisdictional limitation may re-emerge whereby host governments
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that belong to the region may encounter difficulties applying their laws and
regulations to multinational enterprises whose operations extend outside of the
region (Muchlinski 1995:111-12).
One notable shortcoming of the regional
approach, however, is that it may tend to divide the world up into regional blocs
of countries that compete with each other for the foreign direct investment of
multinational enterprises (Muchlinski 1995:111-12; Cf. Dunning 1993:574-8).
6.5.2 (c)
International level of regulation
Host state regulation of multinational enterprises at the international level
involves an international collaborative effort by the majority of the world’s states.
Although this level of regulation would appear to be the most efficient in terms of
rectifying the mismatch between jurisdictional control of host states and the
geographical scope of multinational enterprise operations, it may also prove to be
the most difficult to accomplish. This is because firstly, international regulation
can only take place where national jurisdiction is curtailed, and secondly, given
the great amount of diversity that exists in national ideologies, it would be difficult
to reach an international consensus on how the international regulatory
framework should be constituted (Muchlinski 1995:112-14; Cf. Dunning
1993:574-8; Cf. Modelski ed. 1979:274-5).
6.6 Conclusion
Although all stages within the policy cycle are crucial, in the current context the
most important decisions have to be taken as to the organizational structure
within which multinational enterprise policy will take place. Once multinational
enterprise policies have been studied and formulated, either a new organizational
unit can be developed for the administration of this policy, or an existing
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administrative unit can add multinational enterprise regulation to their functional
responsibilities. A third option would be to leave the current system intact.
Focusing on the first two options for organizing, the key issues here relate to
which option is most efficient in terms of administrative effectiveness and also
which option is most efficient in terms of administrative cost. Resolving these
issues requires a cost-benefit focus of analysis. In this regard, either option will
require additional costs, so before choosing one as the optimal situation, a
cost/benefit assessment has to be made to determine whether the added
benefits of the proposed organizational change(s) justifies the implementing
costs (thus, also addressing the third option of leaving the system intact).
Considering this question first, requires us to specify an objective measure for
the costs to be compared as well as a basis for comparison. Thus, since there is
no current administrative directorate or unit for foreign direct investment and
multinational enterprise policy, comparison has to be made on the basis of the
costs of implementing and maintaining a new system versus the economic and
social costs and benefits related to the current system (i.e. the opportunity costs
of not having a regulatory unit). As has been indicated in this chapter, although
cost benefit analysis cannot provide absolute answers or precise measures, it’s
still remains a worthwhile exercise as it goes a long way towards providing
objective bases for comparison for determining the optimality of organizations
and their structures in terms of their performance.
From the discussion posed in section 6.5 of the dissertation, it can be deduced
that the scope for rationalization of foreign direct investment policy structures in
the South African context can also be partially resolved by firstly taking account
of the Governments ideological stance on regulation, and secondly by making a
determination as to the most effective levels of policy making, implementation
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and mediation of such regulation. Additionally, account must also be taken of a
number of other potentially deterministic factors discussed elsewhere in this
dissertation such as a benefit-cost analysis of a proposed rationalization, applied
organization theory and the economic and social effects that regulated as well as
un-regulated foreign direct investment may entail. These are but a few of the
deterministic factors that have been explored thus far in the dissertation and the
concluding chapter (Infra. chapter 7) attempts to draw to a central divergent
point, each of these considerations in order to recommend the most optimal
basis for the aforementioned rationalization.
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Conclusion and Recommendations
Academic interest and inquiry of multinational enterprises is a relatively recent
phenomenon, as the first serious attempts to understand this type of business
enterprise were undertaken in the late 1950s and early 1960s.
comprehensive works of Coase (1937, 1960), Hymer (1960, 1968) and
Knickerbocker (1973), among others alluded to market imperfections and the
possible disruptive economic forces of multinational firms operating in
developing and third world countries.
Guided by the literature, regulatory
measures were proposed and implemented in a number of countries.
Similarly, this dissertation was primarily concerned with deriving public policy
solutions to economically related public problems. Specifically, one problem
identified for closer examination and in-depth analysis was that of the positive
as well as negative effects on the domestic population of foreign direct
investment by multinational enterprises.
The literature search of the study
identified both positive and negative consequences from this type of investment
on, among other, employment, technology transfer, balance of payments and
environmental damage and resource depletion. In this regard, inter-alia, the
foreign direct investment of multinational enterprises may either increase or
decrease employment, restrict or facilitate technology transfer, improve or
worsen the nations balance of payments, and possibly bypass responsibility for
harming the environment and the peoples of the host state. These issues were
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partially resolved in chapter 2 – A Survey of the Theory of Multinational
A second, and higher order problem also identified for study relates to the
optimization of the positive aspects of the foreign direct investment of
multinational enterprises for the benefit of the host country of such investment.
The study proposed that one avenue by which such an optimization may take
place is through an efficient, effective and well coordinated regulatory
framework. Accordingly, the problem statement of the study is concerned with
the fact that there is no single governmental body at any level of government
that is charged with complete responsibility for policy-making and regulation of
this type of investment in South Africa. This concern is warranted in light of the
possibility of occurrence of the negative effects associated with multinational
The development of a hypothesis brings the study closer to at least a partial
solution of the problem statement as hypothesis testing represents a critical link
between scientific research and its conclusions. Specifically, the hypothesis of
the study is given by the null hypothesis, Ho = There is a necessity to formalize
a Government administrative structure for policy setting and implementation of
multinational enterprise regulation in South Africa.
The extent to which the
hypothesis of the study may have been proved or disproved depended on first
addressing the research question of the study. The research question being –
Is there a need for foreign direct investment policies that apply exclusively to
multinational enterprises?
The research question was answered in the
affirmative throughout the study and especially so in chapter 4 (Supra 4.3.1 f) in
which it was demonstrated that weak or non-existent regulation of foreign direct
investment is likely to leave a nation vulnerable to the negative externalities
associated with this type of investment. The externalities examined in chapter 4
dealt with environmental and health damages caused by foreign corporations
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that exercised certain legal principles to absent themselves from the
jurisdictional reach of host countries.
The hypothesis, on the other hand, was not disproved in the sense that the
evidence in chapter 5 concluded that the current regulatory framework can be
strengthened through the appointment of a dedicated unit that is tasked with
ensuring that the implementation of foreign direct investment policies takes
place in an integrated and coordinated manner in the South African public
sector. It was shown in chapter 5 that several departmental units and sub-units
have some amount of regulatory authority over foreign investors, and without
appropriate efforts at coordination of their activities, policy deficiencies such as
pockets of no-mans land and overlapping may materialize.
Once the issues raised by the research question and the hypothesis had been
established and dealt with, attention was then given to issues of organizing as a
means to giving greater substance to what was implied by the results of the
hypothesis testing. Organization theory was looked upon (in chapter 5 and
more extensively so in chapter 6) to give guidance on assuring that the
appropriate organizational dynamics are in place to optimize the effectiveness
of foreign direct investment policies, and more specifically to optimize the
potential benefits to the Government from inward foreign direct investment.
Additionally, it was argued in chapter 5 that, although there is a body of foreign
direct investment laws and policies, and these foreign direct investment policies
effectively reflect the political ideology of the ruling party, there also exists
significant scope for the integration and coordination of these regulatory efforts.
Summary and conclusions of each chapter
The objective set for the study was to design, develop, and/or propose an
administrative structure (unit) for policy making, policy implementation, and
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control of multinational enterprises where it could be shown that such an
administrative unit is indeed needed.
Each chapter of the dissertation
contributed towards satisfying this objective by either demonstrating the need
for the administrative unit in question, or by attempting to resolve the question
of the optimal structural design of such a proposed unit. A synopsis of the
conclusions of each chapter follows.
Chapter 1 – Introduction
Chapter 1 merely defined the nature and scope of the study in its entirety, and
thus no conclusions were evolved for this chapter.
Chapter 2 – A Survey of the Theory of Multinational Enterprises
The findings of theoretical and empirical research on the effects of inward
foreign direct investment on host governments are an important and instructive
tool for policy makers to take account of in determining the nature and extent to
which multinational enterprises should be regulated. From the review of the
literature it was concluded that the effects of the presence of foreign
multinational enterprises in the host country can be observed through changes
in among other, employment, balance of payments, and the competitiveness of
domestic firms. With respect to the direction of change observed in each of
these factors, consensus in the literature does not exist.
Chapter 3 – Historical Perspective of South Africa’s Investment Climate
The two key conclusions teased out of chapter 3 are that firstly, agriculture,
mining and manufacturing are the three largest sectors of the South African
economy in terms of contribution to GDP and are thus considered the most
relevant in terms of defining the contextual economic environment within which
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foreign direct investment takes place; And secondly, the deterministic element
that runs through every aspect of development and investment in South Africa’s
recent past is the system of racial discrimination and segregation known as
Although apartheid no longer exists, it has left behind a significant legacy that
represents hindrances in many sectors of the economy that are only presently
being resolved. As an example of apartheid’s legacy, it can be noted that the
agricultural sector of the economy has shifted from first to third place in terms of
share of GDP in contemporary times.
The once thriving agricultural sector
benefited white land-owners and farmers at the expense of black farmers under
the system of apartheid. As apartheid was an expensive system to maintain,
there appears to be evidence that the productivity of agriculture was reduced as
a direct result of the apartheid system.
Chapter 4 – Global Foundations for Establishing a Need for the
Regulation of Multinational Enterprises
With respect to foreign direct investment in South Africa, the court case of
Lubbe v. Cape Plc. offers lessons to be learnt (not just for South Africa) on the
issue of regulating multinational enterprises. Cape Plc., an asbestos mining
multinational enterprise, effectively put itself out of the jurisdictional reach of the
South African legal system when it abandoned it’s South African mining
operations in 1979 after allegedly causing asbestos related illnesses to
employees and community members living in the vicinity of Cape Plc. mining
operations. It was demonstrated in chapter 4 that this legal case, in particular,
exposed some of the weaknesses in the South African system of regulating
foreign investment.
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Chapter 5 – Critical Review and Analysis of Existing Policies on
Foreign Direct Investment in South Africa
It was shown in chapter 5 that South African public policy vis-à-vis foreign direct
investment is formulated from a liberal approach that encourages (rather than
restricts) this type of investment. The work of this chapter and the dissertation
as a whole did not seek to argue against this liberal approach, nor did it seek to
support it. Instead, the approach of the study was to take a neutral stance on
the issues and allow the research findings to suggest the degree of
liberalization to be afforded to foreign investors. The main focus of the study,
however, was based on determining the most optimal organizational
structure(s) to be used in managing pre-existing policies on foreign direct
investment. One of the key findings of chapter 5 is that, although there appears
to be a high level of consistency across the South African public sector in what
is being articulated as the government’s policy toward foreign investors, there
are issues of integration and coordination that need to be addressed. As an
example, the powers and functions of the Minister of Minerals and Energy, and
those of the Minister of Environmental Affairs and Tourism overlap in certain
critical areas of control over investors (both domestic and foreign). Although it
is possible to fulfill this coordination function at the executive level through
cabinet committee processes, it was further argued in chapter 5 that this task
would be better handled by a small governmental unit dedicated to all matters
of policy formulation, regulation and monitoring of foreign investment. Further
suggestions as to the organizational dynamics of this proposed unit were also
explored in this chapter.
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Chapter 6 – Rationalization of Foreign Direct Investment Policy
Structures in the South African Government
The work of chapter 6 argued, based on what was demonstrated in chapter 5
and in the literature on organizing and rationalization, that there is scope for the
rationalization of foreign direct investment policy structures in the South African
public sector.
Chapter 3 argued that although an extensive amount of foreign investment
capital was lost to the disinvestments campaign of the 1980s, the extent and
pace at which foreign investment has returned to South Africa in the postapartheid era is one of the defining issues in determining the Government’s
policy approach to foreign investment.
There is also the issue of the low
domestic savings and investment rates that was discussed in chapter 2 (Supra.
Sect. 2.5.4) and chapter 5 (Supra. Sect. 5.7), that serve as a motivator for the
Governments policy of attracting greater amounts of foreign direct investment
into the country.
With respect to the Government’s approach to foreign direct investment policy,
and in spite of the Government’s ideological stance, it is recommended that a
balance must be found between too liberal an approach that may allow for
abuses of the state by multinational enterprises, and too restrictive a stance that
may tend to stem the flow of much needed inward investment capital.
It was demonstrated in the dissertation, through the empirical case approach,
that Lubbe v. Cape Plc. sets an important legal precedence for South African
foreign direct investment law and policy. Comparing Lubbe v. Cape Plc. with
Gisondi v. Cape Plc. demonstrated that South African claimants have little
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support or international legal standing to successfully bring a case for damages
against foreign multinational enterprises, where such multinational enterprises
are no longer domiciled in the Republic of South Africa. Given the facts of
Lubbe v. Cape Plc., it is recommended that the Government look to Article 2 of
the Brussels Convention as a model for bilateral, regional or even international
dispute resolution in cases involving multinational enterprises.
It was shown in chapter 5 that The Minerals and Petroleum Resources
Development Bill (Notice 541 of 2002) and the National Environmental
Management Act of 1998 (Act 107 of 1998) both empower their respective
ministers to expropriate land and/or impose remedial costs for damages from
investors (foreign or domestic). Without the duty on the part of both ministers to
inform and cooperate with each other, duplication, gray areas and loopholes in
the legislative framework are exposed. It is recommended that a coordinating
body be created that will be solely responsible for all aspects of law that have
important implications for multinational enterprise investors. Through such a
coordinating body, all parties involved in specific aspects of law and policy
relating directly or indirectly to multinational enterprises will be able to stay
abreast of what is going on elsewhere in the public domain, that may affect or
be affected by their decisions.
Given that the hypothesis of the dissertation is: Ho = There is a necessity to
formalize a government administrative structure for policy setting and
implementation of multinational enterprise regulation in South Africa; and given
that the null hypothesis was not disproved, Chapter 6 of the dissertation begs
the question of the most appropriate structure for the proposed unit specified in
the hypothesis. A general precept of the physical sciences is that form follows
function, or alternatively, in the language of public administration, strategy
informs structure. Conclusions as to the form that the organizational unit that is
being proposed should take are drawn largely from organization theory with
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specific reference thereunder to rationalization and cost benefit analysis.
Based on the arguments put forward in the dissertation, it is recommended that
a small specialized unit of experts be organized into an organizational structure
that is part of the public service but independent of any other governmental
department or unit.
The unit should work to provide support to other
government agencies in the areas of research, advice and coordination
In order to operate most effectively, this unit should encompass
aspects of both classical as well as neo-classical organization theory. As the
environment within which such an organizational unit operates can be expected
to be relatively stable over time, and the work of the unit highly specialized, it is
envisioned that decision making in the unit will be more centralized than decentralized.
Issues for Further Study
The current study sought to determine the need for an organizational unit that is
fully responsible for the coordination of all aspects of foreign direct investment
and multinational enterprise policy. The study also sought to determine what
this organization will look like in very general terms. The ending point of the
study suggests for further study the detailed design of such an organization in
more specific terms – such as the number of people to be employed, a
determination of the knowledge and skills needed, the remuneration scales to
be applied, communication channels etc.
This would amount to a
multidisciplinary study for one well versed in human resources management,
economics and public policy.
University of Pretoria etd – Moeti, K B (2005)
Cleaver (1997) cautions that “…Free markets embody no mechanism that is
responsive to all the needs of the planet.
Informed regulation is therefore
essential to ensure sustainable development”.
In a free-market system (as
exists in South Africa) minimal government interference in the affairs of private
business enterprises is expected to lead to the greatest possible levels of
economic efficiency. Further, although government’s role in private markets
should ideally be kept to the minimum, there still remains a duty on the part of
government to ensure that certain market conditions exist within which the free
market system can operate relatively unimpeded.
These market related
regulatory responsibilities of government include among other, ensuring that
private markets are free of oligopolistic price fixing collusion and the “unfair
business practices” of monopolists.
With respect to government regulation, multinational enterprises pose a more
complex set of problems than do their domestic counterparts. This is due to the
fact that multinational enterprises are incorporated under the laws of one
country whilst having the flexibility to establish subsidiary or branch operations
in other countries. This being the case it will not always be possible to regulate,
to the full extent of the law, those multinational foreign businesses that choose
to leave the jurisdictional boundaries of the host country. This scenario has
played itself out in Lubbe vs. Cape Plc. (Supra 4.3.1 (d)) in which the asbestos
mining and supply company, Cape Plc abandoned it’s South African mining
operations and sought legal protection in the UK courts from South African
litigants who suffered health damages as a result of Cape Plc operations. The
current study examined Lubbe vs. Cape Plc and recommended that the
Brussels Convention stood as a model from which to frame and resolve future
similar incidents.
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Although equally important, in the current study policy issues were secondary to
organizational dynamics most suited to addressing foreign direct investment
policies in South Africa. The major concern addressed by the study in this
regard is the fact that there currently exists no unit of government in South
Africa that is tasked solely with overseeing and coordinating policies that relate
to the foreign direct investment of multinational enterprises. Establishing the
need for and the development of such a governmental unit has been the
primary concern of the current study as well as being the basis upon which
issues for further research were proposed.
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