Entrepreneurship in Asia and Foreign Direct Investment

A look at local entrepreneurship in four economies in Asia offers a fascinating lens on Foreign Direct Investment, says HBS professor Yasheng Huang. Discussing his new research proposal at an HBS International Seminar recently, Huang also offered insights on what it might mean as China rises.
by Martha Lagace

Foreign Direct Investment (FDI) is often lauded for bringing economic growth and know-how to developing countries. The conventional wisdom is not necessarily wrong, but the real story is much more nuanced than is commonly believed, says HBS professor Yasheng Huang.

As he is discovering in new research, the relationship that exists between FDI and local entrepreneurship in Asia may be one important reason why certain Asian countries developed differently from others, despite surface similarities.

This angle on FDI may offer a window into why Singapore and Malaysia, for instance, seem to be worried about the ascendance of China, while firms in Taiwan and Hong Kong have reaped enormous benefits from Chinese economic expansion, according to Huang. He presented his new research proposal to an audience of faculty and doctoral students at an HBS International Seminar on May 17.

According to Barron's Business Terms, FDI is "investment in a country by foreign citizens, often involving majority stock ownership of an enterprise."

Huang is looking deeper into how and why FDI played quite different roles in these four economies in Asia. While cautioning that this research is just getting underway and is not conclusive, Huang believes that the study of FDI in the context of local entrepreneurship in Asia deserves a closer look.

"I'm not claiming local entrepreneurship is the only determinant of FDI," he said, "but it could be an important determinant that is often ignored."

I'm not claiming local entrepreneurship is the only determinant of FDI, but it could be an important determinant that is often ignored.
— Yasheng Huang

Fdi And Asian Economies

Huang has made the case that China's reliance on FDI is not necessarily a sign of a healthy economy. As he wrote in the forthcoming book, Selling China: Foreign Direct Investment during the Reform Era, to be published in October 2002 by Cambridge University Press, a complete picture of FDI in China needs to acknowledge how China's financial institutions have also failed to allocate domestic capital efficiently.

His new research applies a similar framework to Hong Kong, Taiwan, Singapore, and Malaysia. He wants to compare these four Asian economies because on the surface they share a similar perspective on FDI: They all welcome it (though Hong Kong is more neutral, he said). His data stretches back to the 1960s and forward through the early 1990s so he is able examine the process of economic development of these four economies and their relationships with FDI.

Huang is especially interested in FDI that went into labor-intensive industries such as bicycles, textiles, and garments. In labor-intensive industries, contractual arrangements with foreign buyers are technically feasible and might provide the same business benefits as FDI. (As a form of equity financing, FDI is typically prominent elsewhere in the world in those industries that involve substantial research and development and complicated organizational know-how, such as the pharmaceutical and electronics industries.)

"The FDI that I'm looking at also has gone into industries in which the local entrepreneurs in these economies started out with some substantial capabilities, in the early 1960s," he said. All four economies "are successful economies and export powerhouses."

What is interesting, according to the data he presented, is that Hong Kong and Taiwan did not rely on labor-intensive FDI to develop their export capabilities, whereas Singapore and Malaysia did—and did so heavily—in the 1970s and 1980s. On a macroeconomic level these four economies did not differ that much; they all had high savings rates, healthy growth prospects, political stability, and cheap labor.

Local Entrepreneurship, Yes Or No

A far more important driver of FDI is at a micro level: FDI is determined in part by the strength or weakness of local entrepreneurship in host countries, Huang argued. The institutional quality of an economy, which affects the efficiency of capital allocation and the security of property rights of productive and innovative entrepreneurs, influences the supply of local entrepreneurship in an economy. Poor institutions reduce the supply of local entrepreneurship; high quality institutions increase local entrepreneurship.

"By that logic, at a given level of macroeconomic [and] macropolitical fundamentals, a country gets more or less FDI depending on the strength of local entrepreneurship. If a country with strong macroeconomic and macropolitical fundamentals is also strong at a micro level—at an entrepreneurship level—then the country actually may not get much FDI," he said. Local firms may pose a serious competitive threat to foreign firms, at least in certain industries, and foreign firms will think twice before entering into such a market."

"My question is why FDI finances 40 percent of investment in Malaysia vis-à-vis Hong Kong where FDI finances about 10 percent," Huang continued. "I am mainly interested in studying FDI relative to domestic investment and FDI relative to contractual methods of alliances between foreign firms and domestic firms."

One of the reasons why labor-intensive FDI was more important in Singapore and Malaysia in the 1970s and 1980s, he hypothesized, could be due to the fact that small-scale private entrepreneurs could not access sufficient local financing, as much of the domestic capital went to state-owned enterprises. Labor-intensive FDI brought forth both resources and business opportunities in the form of an export contract—but contractual arrangements only brought forth a business opportunity.

In a nutshell, the four economies he is studying seem to fall into two basic categories: Broadly speaking, FDI was more important to the economic development of Singapore and Malaysia because domestic firms there were weaker than in Hong Kong and Taiwan, he said. Singapore and Malaysia had weaker domestic firms in part due to a deliberate governmental bias against private local firms, mainly in the 1960s and 1970s, he continued, so foreign firms held a more substantial relative advantage. But in Taiwan, the government provided a sponsorship and financing role, not a managerial role as in Singapore and Malaysia. Capital in Taiwan and Hong Kong went to the most efficient firms, including small, start-up entrepreneurial firms, and was not based on the political or ethnic status of such firms, he said.

Extremely attractive compensation packages in the public sector also mean that the most talented people in Singapore want to work for the government.
— Yasheng Huang

Private Firms And Political Bias

To understand the reason for the bias against private firms in Singapore and Malaysia in the 1970s, Huang contends, one has to know something about the political context of these two countries at the time.

In Singapore, the government faced a serious threat from the left-wing political forces and some in the Chinese establishment—in media, education, and business—were sympathetic to the Communist movement in China. Many years later, Lee Kuan Yew, prime minister from 1959 to 1990, would write in his memoir, "It is impossible in Singapore's political climate of the 1990s to imagine the psychological grip the Communists had on the Chinese-speaking in the Singapore and Malaya of the 1950s and 1960s."

In Malaysia, the racial and ethnic situation was even more complicated, with Chinese controlling much of the economy and Malays controlling the politics. The economic and political inequities would culminate in a large-scale riot in 1969, in which racially motivated attacks resulted in thousands of deaths. Thus, for many years afterward, both regimes would become wary of a strong—and mainly Chinese-dominated—business class. In this context, FDI as well as public sector firms proved very valuable in a political sense.

Huang stresses that he does not question the political rationale behind those policies that resulted in a bias against local private firms. He also adds that in the 1980s as the political and ethnic tensions eased in Singapore and Malaysia, governments there also began to remove some of the biases against local firms. What Huang wants to convey, however, is the fact that a historical policy stance biased against local private firms did entail real economic consequences.

One consequence is the fact that Singapore and Malaysia are extremely reliant on FDI. While this reliance has its benefits, it may also have some costs. For example, as Huang explained at the seminar, many businesspeople in Singapore and Malaysia appear to think of China mainly in terms of a looming competitor for the same FDI they try to attract, whereas firms based in Taiwan and Hong Kong view a rising China as representing an enormous investment and trading opportunity. The latter two economies have strong local firms that stand to benefit enormously from China's growth. Governments, which in the past promoted FDI to the neglect, or even to the detriment, of local firms, may face increasing difficulties in the future. This line of thinking ought to entail important policy implications.

Singapore: The Importance Of Competitive Pay

The other cost is associated with the support of public sector firms. Huang argues that state interventions are a breeding ground for corruption, but in Singapore, the government solved this problem in a unique way—by paying civil servants competitively or even better than managers in the private sector. This practice does curtail corruption, as indicated by the fact that Singapore is one of the cleanest countries in the world, but it also has a huge cost. Huang pointed out in his presentation that Singapore and the United States rank similarly on Transparency International's corruption index, but cabinet secretaries in the United States are paid a fraction of salaries compared to the salaries received by government ministers in Singapore. Thus, Singapore has managed to achieve the same level of institutional quality as the United States but has done so at a greater financial cost. The money that financed the maintenance of high institutional quality cannot be used for other things (such as investing in a local R&D base), that might have pushed the country into a deeper reliance on FDI.

Extremely attractive compensation packages in the public sector also mean that the most talented people in Singapore want to work for the government. The private sector is far less lucrative and attracts lesser talents. In the long run, this will be detrimental to the development of a vibrant private sector in Singapore.

Huang has discussed his work at the Organisation of Economic Co-operation and Development (OECD), the World Bank, and International Monetary Fund, and he hopes that examining the role of FDI in these four Asian economies, in addition to the work he did on China, will stimulate further academic and policy debates on this topic.

About the Author

Martha Lagace is senior editor of Working Knowledge.