Foreign direct investment benefits in North Korea and underdeveloped countries

Political Science

International Relations

Definitions of Beneficial and Detrimental

Investing in North Korea by South Korean Companies

Case Where the Company Alone Benefited

Case Where both the Country and the Company Benefited

Measurement of Benefits -- Political Considerations

Corporations and Ethical Practices

Egregious Failures, Notable Successes

This paper covers three investments in underdeveloped countries with varying experiences on the part of the companies and the countries involved. It will then discuss the relative advantages of FDI (foreign direct investment) on countries and their citizens in light of these experiences and those with other similar types of investments. Three types of examples will be used: an example in which the country benefited but the company investing did not, a case where the company investing reaped all or most of the benefits and the country was bereft, and an example where both the company and the country benefited from the FDI.

Definitions of Beneficial and Detrimental

Economists would argue that FDI and free trade benefit the populace generally. The same may not appear to be so in the country at the time of FDI or the imposition of free trade. The problem is that free trade disadvantages specific interests while benefiting the populace overall (Feulner, 2007). if, for example, foreign coal is less expensive than British coal, the public benefits through relatively lower heating costs, and industry from lower fuel costs. But at the same time, those who toil underground in the UK, their unions and the coal mine owners are disadvantaged. To the degree that these groups have political clout, they can skew the system to bring them specific advantage, even if the rest of society loses the benefit.

In this paper, beneficial must therefore be properly defined: of benefit to the greatest number in a society (even if some individuals are hurt).

On the other side, beneficial to a government may not be beneficial to the citizens. In the example of North Korea, it is clear that Kim Jong Il and his cohorts benefited greatly by an under-the-table payment of $500 million. The people of North Korea, on the other hand, were not helped at all. Benefits came to a select few, at the expense of the corporation doing business with that country.

Investing in North Korea by South Korean Companies

North Korea, desperate for liquid currency and cognizant of South Korea's wish to open doors with the North, decided to acquiesce to a South Korean request to develop a "free trade zone" in the North. Led largely by Hyundai, a major South Korean "Chaebol," or business conglomerate, the firm decided to create such a zone with a significant investment.

Hyundai developed a resort in North Korea with an investment of $500 million. The company brings tourists from the South and shows them to a mountain resort, and complete the tour at an industrial park where tourists can buy kitchen utensils and clothing made in the park by North Korean workers (Song-Hun, 2005).

Although the government of North Korea promised additional development and franchise rights to Hyundai, little has materialised from Hyundai's investment so far. Its mountain resort, called Mount Kumgang, loses money. It has not worked as a way for South Koreans to meet North Koreans, as the resort is fenced and guarded from outside intrusion by North Korean troops. Most of the money which Hyundai invested with the North Korean government to build and maintain the facility is suspected to have gone into the pockets of North Korea's leader, Kim Jong Il.

Hyundai needs 1 million visitors per year, but has had only 550,000 total visitors since 1998. Attempts to increase traffic, through completion of a cross-border railway and overland routes, has been halted by the North Korean government with no notice.

Hyundai has paid $942 million to obtain 'exclusive' rights to develop seven projects around the country of North Korea, plus $500 million in a bribe to the central government in order to ensure that Kim Il Sung would agree to the deal (Lakschamanan, 2003).

By 2005,the relationship between Hyundai and the North Korean regime reached an even lower point. Top officials announced a review in that year of all concession rights. At the same time, the government opened secret talks with the Lotte Group, a South Korean competitor of Hyundai (Faiola, 2005). For understandable reasons, Lotte managers decided not to continue the discussions.

Why would Hyundai consider such a large investment in an unstable and clearly hostile country? Furthermore, why would it rely on the promises of North Korea to deliver a 50-year concession for a series of developments in the country? Several reasons suggest themselves, including government prodding, nationalist feeling and hubris on the part of Hyundai executives.

Hyundai had made the decision to invest at a time when relations were thawing between the two countries. The announced "Sunshine Policy," led by South Korea, posited that the North would be more receptive to "soft" tactics than hard tactics, despite the reservations of its close ally, the United States. Hyundai, a family-controlled company, was doubtless thinking of the advantage that it could obtain over other South Korean rivals by being first into the country. The fact that Lotte let its name be circulated in the news shows the extent to which the Chaebols compete with one another.

Case Where the Company Alone Benefited

Standard Oil was a virtual monopoly in the United States until the Trust Busters broke their 30-year lock on transportation. Oil was first discovered in Pennsylvania and the Ohio Valley in the 1860's. At that time, it was viewed as a replacement for whale oil in lamps, and kerosene was by far the most sought-after petroleum product.

Standard Oil pioneered many practices which led to the widespread use of petroleum products, but its masterstroke was the shipping concession on the Ohio River, which was the gateway to the Mississippi. John Rockefeller arranged secret transport deals with railroads and shipping companies which gave him significant competitive advantage over smaller competitors. By they buying some of his competitors, he ended up with a monopoly on shipping at reasonable cost, which drove all other competitors out of business (Schifferes, 2000) (Weinberg, 2001)

The nation was clearly disadvantaged by Rockefeller's moves. The Trust built by Standard Oil required that competitors play along, be acquired, or go out of business (Chase, 1947). Since, at that time, oil was relatively concentrated in areas where Standard Oil could impose monopoly or exclusive shipping arrangements, the company earned outsized profits as a result of its situation.

Measurement of Benefits -- Political Considerations

In politics, measuring benefit can be difficult when comparing two economic alternatives. Economists can demonstrate how, in the aggregate, consumers and industry benefit from free trade. In the process of creative destruction, however, some industries and workers are displaced by the changes wrought by free trade.

The measurement of benefit in the case of Volkswagen continues to reverberate today, after over 25 years. When VW entered the Chinese market, it did so over the objections of its local labour unions and politicians. Part of the objection came because the State of Lower Saxony controlled 20% of the shares, and the government was concerned about the loss of jobs in its domestic sector. The managers of VW saw it differently: by creating a successful and growing subsidiary in China, the reasoning went, the company could increase its generated cash and derive strategic benefits from finding a lower-cost supplier of parts.

There were, however, forces to overcome:

Unions threatened to strike in Germany unless the management agreed not to export their jobs to China.

The ruling SPD (social democrats) suggested that VW was aiding and abetting a repressive regime, and that its ethics were therefore in question. The VW team argued that, by bringing Western practices to the country, they were hastening the process of democracy.

Thus an example of clear consumer and citizen benefit, points to the difficulties of standing up to entrenched interests and prevailing over their narrow concerns.

Corporations and Ethical Practices

The old paradigm (pre-Internet) was that companies could seek the lowest-cost production around the world, and the environment, ethics and labour practices took the hindmost. This practice is now changing, as companies are held to a standard of behaviour regardless where in the world they do business. The cost to the companies -- apart from any legal regulation -- are too great to ignore. The primary costs to companies are a loss of prestige, and therefore market image. In addition, corporations found to engage in dodgy behaviour, such as bribes, must declare that behaviour on their public statements, or face securities laws violations.

Companies which do business with rogue regimes and dictatorships face similar restrictions on their activities today. This can pose significant business and ethical dilemmas. Shell faces a problem in the Nigerian Delta, where it is square with the national government, but local officials and citizens feel that they are being treated poorly. Shell is left to square the circle -- satisfying the central government while lobbying that same government to treat its delta citizens more fairly.

Egregious Failures, Notable Successes

The era of big Trusts is behind us, for the most part. If Microsoft, for example, engages in monopolistic bullying, it will be pursued in courts in one or more regions of the world. If the U.S. Federal Trade Commission refuses to prosecute Microsoft for abusing its Windows franchise, the European Trade Commission can step in. If the Chinese government attempts to quash free internet access with Yahoo's search engine, the American and European governments and courts can step in to press for more freedom.

As we've seen from the above examples, the greatest abuses come from corporate monopoly power or corrupt, megalomaniacal or authoritarian governments. When states allow companies to compete fairly and openly, the chances of notable failures (for the companies and for the local citizenry) are diminished.