Governance and Foreign Investment in China, India, and Taiwan: Credibility, Flexibility, and International Business

Chapter 1. Political Institutions, Governance, and Foreign Direct Investment

Chapter 1 Political Institutions, Governance, and Foreign Direct Investment On March 22, 2010, Google, the company providing the world’s largest web search engine, decided to pull its search service out of China, the largest Internet-­using country. Google spokespersons claimed that the company could no longer tolerate the excessive Internet censorship and cyber spying there. A few days later, Rio Tinto, an Anglo-­ Australian mining giant, was accused of harming China’s economic interests. Four of the company’s employees were charged with bribery and received harsh sentences, after the initial allegation of stealing state secrets was dropped. Both the European Union Chamber of Commerce in China and the American Chamber of Commerce in China have issued reports complaining about a deteriorating business environment in China (Johnson and Dean 2010). Meanwhile, Arcelor Mittal, the world’s largest steelmaker, faced a severe challenge in India. It had not been able to acquire land for five years for its proposed projects in the mineral-­ rich states of Jharkhand and Orissa. Instead, its plan for land acquisition spurred massive demonstrations by the tribal community . Armed with the traditional bow and arrow, villagers went head-­ to-­ head with the global steel giant and cried, “We may give away our lives, but we will not part with an inch of our ancestral land” (Basu 2010). These incidents have fueled a global debate about the investment climate in these two vast and booming economies. Although the statistics suggest a more worrisome picture in India,1 the Indian Express, one of the most influential newspapers of the Indian subcontinent, defended India’s investment prospects: 2 governance and foreign investment in china, india, and Taiwan “While, the current, and normal, level of social unrest in India might be much higher than in China, there was much less of a risk in India that social unrest could suddenly escalate to the point where the political system itself is vulnerable or foreign investors are forced to re-­ evaluate their assessment of risks” (May 17, 2011). This claim highlighted an important question of international political economy: what political attributes make a developing country attractive to foreign investors? Behind this claim stands a large and growing—­ if more nuanced—­ literature in political science and related disciplines. The classic literature of political economy emphasizes the critical role of governments’ credible commitment for creating a mechanism conducive to the private investment necessary for countries seeking rapid economic growth. Governments’ commitments are made credible by self-­ enforcing institutions, such as constitutions or an independent judiciary, which underlie limited governments (North 1990; North and Weingast 1989). Authoritarian regimes, given the absence of checks and balances, are regarded as unlikely or even incapable of making credible commitments. Is democracy or autocracy more conducive to foreign direct investment (FDI)? Anecdotal evidence has not provided a definitive answer. Cross-­national quantitative studies are equally inconclusive. That China is one of the largest recipients of FDI while it is ruled by an authoritarian leadership challenges the view claiming the superiority of democratic regimes. One may point out China’s unusual advantages—­its size, high growth rate, and abundant cheap labor—­but it is not exceptional as an authoritarian regime that happens to attract a large amount of FDI. Brazil, Argentina, Indonesia, Malaysia, and Vietnam have all been successful in attracting FDI under authoritarian governments. Of course, we can also spot numerous examples of failed authoritarian regimes. Indeed, foreign firms would need tremendous courage to consider investing in Robert Mugabe’s Zimbabwe or Kim Jong-­ un’s North Korea. If a certain type of political regime is more conducive to FDI, how can we explain divergent FDI performances in countries with similar political institutions or similar performance under distinct political institutions? Although finding the answer is difficult, a dichotomous explanation in favor of either political regime can be rejected, for several reasons. First, there is lack of direct linkage between the political regime and foreign investment. As Fukuyama (2011, 5) points out, “The mere fact that a country has democratic institutions tells us very little about whether it is well or badly governed .” Although property rights institutions, the fundamental determinants of Political Institutions, Governance, and Foreign Direct Investment 3 investment and output (Acemoglu and Johnson 2005), are endogenous because democratic countries tend to have better protection of property rights, there is a lack of clarity about how such protection, particularly from private trespass, is strengthened by democratic institutions...