Emerging Markets Want More from Investors
Chief executive officers of Western multinationals will have to do a better job of articulating why their investments in emerging markets are positive for the economies of those countries, says Ethan Kapstein, professor of sustainable development at INSEAD, the international business school in Fountainbleu, France. Kapstein says governments of countries such as China are becoming more selective about which foreign investments they will accept. Here are edited excerpts from a recent conversation:
Which countries are we talking about?
Most foreign direct investment takes place in a very small number of emerging markets, such as China, India, Brazil, Israel, and a few others.
How is their attitude changing?
I see a change that's spreading pretty much globally throughout developing markets. Latin America is on the cutting edge of a lot of the debate. As a region, in the 1990s, it had the greatest share of foreign direct investment outside the industrial world, and after a decade they had no growth to show for it. This led policymakers and economists to ask why. Part of it has to do with domestic governnance issues. But part of it was the way that multinationals invested.
Are you saying these countries don't want investment just for the sake of investment?
Exactly right. When I was in graduate school in the last century, I learned that foreign direct investment was good for simple macroeconomic reasons. The developing countries didn't have a lot of savings. They were poor. Any investment from overseas augmented domestic savings. That had to be good.
But what really matters these days is the quality of the investment and in particular the impact on local supply chains, which is really what drives development. As multinationals increasingly go toward global sourcing, the issue is: What are the implications for local supply chains? Are they going to get the spillover effect? This question is being raised in countries like China that have enjoyed billions and billions of dollars' worth of investment.
So the Chinese are increasingly looking for certain kinds of investment that have certain kinds of impact?
Yes, the Chinese are interested in investment that will create spillovers into their domestic economy. They want technology that the Chinese are not creating themselves yet. They want investment that results in human-capital formation, meaning companies train workers in a very high-skilled way. They want organizational and logistical talent that local firms may lack. All of this will create more lasting growth.
If I'm the CEO of a major Western company, how do I need to change my approach to investing in these countries?
That's a critical question—and it's a new question on the agenda for business leaders. What they're really going to have to think about is how do they balance between their short-term economic calculations vs. the longer-term development objectives of the countries in which they want to do business.
Countries like China, Brazil, and India can drive a hard bargain. They can say, "If you want to do business in this country, you're going to have to do certain things for our supply-chain development or our technology base." I think we are moving into a world like that.
Is part of the reason for the changed attitudes the fact that these countries are now sitting on large foreign exchange reserves?
A lot of these countries are sitting on huge amounts of cash, so their need for foreign direct investment to make up for the lack of domestic savings is not as intense as it was a few years ago. They have the luxury of being more discriminating.
How much money has been invested in these countries in, say, the last 10 years?
Somewhere around half a trillion dollars from companies in the advanced industrial nations. [Investments in] Latin American countries alone accounted for $300 billion in the 1990s.
How do CEOs need to explain the effects of their investments?
They really have to move beyond corporate social responsibility reporting where they say, "We've invested in hospitals and schools," to providing real data about their impact. I've recently done a report along these lines for Unilever in South Africa. I used South Africa government statistics and corporate financial statistics to analyze, in very hard terms, the impact of Unilever's presence in terms of employment generation, use of local suppliers, tax payments, and the like. Very few companies have wanted to look at the facts in this way.
In broad terms, what is Unilever's (UL) impact?
Unilever has 4,000 direct employees, but its presence supports 100,000 jobs, directly and indirectly. It accounts for 1% of the government's tax revenue, directly or indirectly, and it has 3,000 suppliers, directly or indirectly. These are huge numbers.
But you found that as Unilver turns to suppliers that can meet the company's needs all around the world, it runs the risk of taking business away from its South African suppliers who just operate in that country?
Yes, that's why I believe the CEOs of multinational firms have to have a dialogue with governments about the competitiveness of the local supply chain. This is not corporate social responsibility. Those markets will only grow if they have strong local supply chains. The multinationals have a vested interest in assuring the competitiveness of those supply chains. So investments must be made in education, infrastructure, technology, and research and development.
Are governments like China's also beginning to look at the environmental impact of foreign investment?
Multinationals are expected to bring best practices in everything they do. If you're not bringing best practices, there's not much interest. In environmental policy, like these other sectors, you have to be able to show what you're doing with data.
If multinationals do all the things you're suggesting, in terms of supply chains and technology transfer, won't they be creating companies that can compete against them?
My mentor, Raymond Vernon, the great Harvard professor, argued to multinationals years ago, "You guys can stay on the cutting edge only by investing in research and development and by constantly coming up with new products." I think that's the lesson.
Competition is happening. It's happening very quickly. I think firms have to invest in their human capital, skill formation, and their supply chains in their home countries if they want to maintain their competitiveness.
How is your argument about explaining the benefits of multinational investment going over with CEOs?
I'm not sure it's even dawning on them yet. The problem is that most CEOs are so focused on the next quarter that it's very hard for them to think broadly. Most of them have not had much experience in the emerging world. I don't think they've thought about these issues in a very analytical way. We've got a long way to go.
Are the Organization for Economic Cooperation & Development, or the World Bank, or the International Monetary Fund thinking about these issues?
They're still focused on government policies, not on the private sector. And it is the private sector that's going to drive development.