LA INDUSTRIA MILITAR PRIVADA: LOS EFECTOS DE LA PRIVATIZACIÓN DE LA SEGURIDAD.

This chapter is designed to address a number o f issues that are pertinent to the empirical analysis that we intend to undertake in subsequent chapters. It is divided into five sections. The first section discusses the mechanisms through which foreign direct investment may contribute to economic growth. Section two reviews the theory behind international trade and investment, with particular reference to attempts made to include the role of multinational enterprises. The third section discusses regionalism and FDI, including a brief history of the North American Free Trade Agreement and the European Union. Section four offers a critique o f the gravity model, an empirical model commonly used to estimate trade and investment flows. Section five concludes.

2.1 GROW TH EFFECTS OF FOREIGN DIRECT INVESTMENT

Over the last half-century nations have become amazingly more receptive to foreign direct investment (FDI). Back in the 1960s and 1970s FDI was blamed for all manner of ills that beset countries, from local firm closures to national unrest. Nations looked to the example of Japan, whose refusal to permit FDI seemed to give rise to a remarkable success story. However, rapid growth in world trade, the liberalisation of many economies (e.g. China post-1991) and national industries (e.g. telecommunications), and Japan’s 1990s decline foreshadowed a remarkable change in attitude towards FDI. Whilst multinational enterprises clamoured to invest to penetrate new markets and exploit previously inaccessible resources, nations began to appreciate the potential benefits of FDI and were soon fiercely competing to attract it.

FDI has become closely associated with the phenomenon known as ‘globalisation’. For all the rhetoric, globalisation lacks an exact definition and means different things to different people. It is probably best used as a term to describe the increasing integration of national markets and the worldwide division o f production (which has caused geographical separation of the value-added chain). The main drivers of globalisation are multinational enterprises (MNEs) that strive to access new markets and minimise production costs through international investments (i.e. FDI). Despite the now widely- held view that FDI is beneficial for the host economy, there are those who consider globalisation to be a capitalist tool designed to exploit developing countries. In one sense, the close link between FDI and globalisation has been beneficial, because the furore over globalisation has heaped enormous attention on FDI, both in academic journals and the popular press. However, it has also meant that they are frequently ‘thrown in the same boat’ and consequently many erroneous statements and claims as to the benefits or otherwise of FDI have been made. In order to ensure that the same mistake is not made here, we begin by grounding our analysis in economic theory.

The neoclassical growth model is typically expressed as a Cobb-Douglas production function with two inputs, capital (K) and labour (L):

Y = K a(A L f-a [2.1]

exogenous rate ‘g ’) and ‘A U can be thought o f as units o f effective labour (which incorporates both the quantity and productivity of labour as goyemed by the level of available technology). We assume constant returns to scale (CRS), but diminishing returns to individual factors. Under this specification, FDI inflows are modelled simply as contributions to capital (K) and, therefore, there is no distinction between foreign and domestic investment. As the model assumes CRS with diminishing returns to capital accumulation, increases in national output will diminish as the stock of inward FDI (and domestic investment) accumulates, if not matched by proportionate increments of AL. In this manner, the neoclassical model predicts that economies will converge towards a steady-state equilibrium1. The level of the steady state is determined by the positive influences of FDI and the domestic saving rate and the negative effect of population growth. However, the growth rate of the economy at its steady state is governed purely by the exogenous rate of technological progress, ‘g \ Therefore, the neoclassical model permits FDI only a short-run effect on growth (the length o f which is determined by the economy’s transitional dynamics to its steady state).

Obviously the neoclassical model is completely inadequate for analysing the potential growth effects of FDI. Its narrow specification constrains FDI to having the same characteristics as domestic investment. As Graham & Krugman (1991) observe, domestic firms will surely have superior knowledge and access to domestic markets. If a foreign firm is to enter these markets it must counter these advantages with some of its own. It is quite plausible that these advantages may be embodied (at least to some extent) in the

1 Steady-state equilibrium is an equilibrium in which each variable is either constant or growing at a constant rate.

firm’s FDI and may therefore spillover to the host nation. As such we require a growth model which will permit FDI to have differing characteristics and effects from domestic investment.

Fortunately, such a class of growth models was developed during the 1980s as a response to the inadequacies o f the neoclassical growth model. Many questioned the power of the neoclassical model, which they saw as unable to explain the causes of long-run growth itself. What they sought was a model that could illuminate the causes and determinants of technological progress. As Romer (1994: pp.20/21) writes:

“if we make use o f all of the available evidence, economists can move beyond these [neoclassical] models and begin once again to make progress toward a complete understanding o f the determinants of long-run economic success. Ultimately, this will put us in a position to offer policy-makers something more insightful that the standard neoclassical prescription - more saving and more schooling. We will be able to rejoin the ongoing debates about tax subsidies for private research, antitrust exemptions for research joint ventures, the activities of multinational firms, the effects of government

procurement, the feedback between trade policy and innovation...”

...and so the list goes on. These attempts to make use of all of the available evidence and ensure that relevant variables were determined within the model led to the creation of endogenous growth theory.

“Increasing Returns and Long-Run Growth”, published in the Journal o f Political Economy and Lucas’ (1988) paper, “On the Mechanics of Economic Development”, in the Journal o f Monetary Economics. Endogenous growth theory encompasses a number o f different models whose common characteristic is that they endogenise one or more factors which neoclassical theory takes as exogenous. Significantly, they also allow non­ diminishing returns to capital. This is normally due to externalities arising from industry­ wide or economy-wide accumulation of human capital (Romer [1986], Lucas [1988]). However, we can develop a simple endogenous growth model that permits increasing returns to capital due to FDI inflows:

Yj = K a djK11 f j Hz j (A L K ftc [2.2]

where 7 ’ is a firm subscript and Kfe e is economy-wide accumulation of FDI (with the ‘e’ term capturing the externality or spillover effect on the output of firm j). Each firm faces constant returns to scale in its reproducible factors (domestic capital, foreign capital, human capital, and effective labour) but due to positive externalities from Kfe 6 enjoys increasing returns overall. Therefore, whilst the simple neoclassical model regards FDI simply as a direct substitute for domestic investment, endogenous growth models (as illustrated above) acknowledge that FDI is crucially different from domestic investment and that it can benefit the host economy by means of transferring technological, managerial and organisational know-how.

Another interesting feature of endogenous growth models is that they typically do not

predict convergence (in the per capita incomes o f countries) because o f their allowance for increasing returns2. In terms o f the endogenous model we developed above, despite a single firm experiencing diminishing returns to domestic (Kdj) and foreign investment (Kjj), the economy-wide accumulation of FDI (Kfe) results in positive spillovers for the firm which permits it to enjoy increasing returns overall. If we assume that it is possible to aggregate this result across all firms in the economy, then that economy may be able to enjoy unbounded growth (subject to sufficient inflows of FDI).

Does our model therefore predict that the United States, which has consistently been the largest recipient of FDI in recent years (with the exception of 2004 - see Figure 1.1), will experience the fastest growth rate in the world (at least while it maintains its dominance in attracting FDI)? Not exactly, for we have neglected to discuss the importance of the externality capturing term (e). Whilst economy-wide accumulation of FDI offers nations the potential to benefit from spillovers, their ability to exploit this potential is limited by their ability to absorb and utilise it3. Paying respect to the work of Moses Abramovitz (1986, 1995) we may call this ability a country’s ‘absorptive capacity’. Many factors are likely to influence a country’s ‘absorptive capacity’, but the most important ones are likely to be the level o f human capital, the state of technology and infrastructure, government policies, and the sophistication of financial institutions and markets. Therefore, a country that is lacking in these factors may have a low ‘absorptive capacity’

2 However, Paul Romer (1994) regrets the influence convergence has had on the development of