VIRTUALLY ALL THE EMPIRICAL investigations into the causes and consequences of FDI use single-equation models. Here I estimate the five-equation macroeconomic model developed in Chapter 3 for a sample of sixteen developing countries (Argentina, Brazil, Chile, Egypt, India, Indonesia, Korea, Malaysia, Mexico, Nigeria, Pakistan, Philippines, Sri Lanka, Thailand, Turkey, and Venezuela). The results provide some new information on the direct and indirect effects of FDI inflows to this sample of developing countries. They also provide some strong indicators of the problems to be faced and pitfalls to be avoided by developing countries embarking upon policies to promote FDI inflows.

Foreign Direct Investment and Domestic Investment

THE REGRESSION METHOD used here is iterative three-stage least squares which is, asymptotically, full-information maximum likelihood (Johnston 1984, pp. 486-92). I estimate the sixteen individual country investment equations as a system of equations with cross-equation equality restrictions on all coefficients except the intercept. Hence, the estimates apply to a representative member of this sample of developing countries. The estimation technique corrects for heteroscedasticity across country equations and exploits contemporaneously correlated disturbances. The instruments are the exogenous explanatory variables plus the lagged FDI ratio, lagged domestic credit expansion divided by GNP, the lagged terms-of-trade index in natural logarithms, lagged growth, the public sector borrowing requirement divided by GNP, the world real interest rate, oil price inflation, and the rate of growth (continuously compounded) in OECD output. The estimation period is 1966-88 except for Brazil (1966-85), Chile (1966-84), Indonesia (1967-88), and Pakistan (1968-88).

Table 5 gives three estimates of the investment function with the current FDI ratio and three estimates with the average FDI ratio over the previous five years FDIYL instead of the contemporaneous FDI ratio. For the complete sample, the foreign debt ratio reduces the domestic investment ratio, while the rate of economic growth increases it, as anticipated.

I was asked “to provide an overview of the American democratic experience high-lighting the unique set of motivations and circumstances fueling democratization in the United States, and secondly, emphasizing the distinctive aspects of the process which are in contrast to the Asian experience”. That is rather a tall order. I shall attempt, nevertheless, to supply at least some basis for the discussion of these issues by setting forth five propositions dealing with: (1) the nature of democracy in general; (2) the development of democracy in the West; (3) the nature of American democracy; (4) the prospects for Asian democracy; and (5) the possible nature of Asian democracy.

The Nature of Democracy

First, what do we mean by democracy? To compare American, Asian, or other varieties of democracy it is first necessary to define the genus of which these are species. What is the essence of all democratic regimes that distinguishes them from non-democratic systems? Fundamentally democracy is a means of constituting authority in which the ruled choose the rulers. In other types of political systems, people may become rulers by virtue of birth, appointment, lot, examination, wealth, or coercion. In democracies, in contrast, either the rulers and ruled are identical, as in direct democracy, or rulers are selected by vote of the ruled. A modern nation-state has a democratic political system to the extent that its most powerful decision-makers are selected through fair, honest, periodic elections in which candidates freely compete for votes and in which virtually all the adult population is eligible to vote. This procedural definition of democracy differs from definitions of democracy by purpose or by source of authority. It received its most significant modern exposition in Schumpeter's Capitalism, Socialism, and Democracy and is now almost universally accepted by scholars working on this subject. According to this definition, elections are the essence of democracy. From this follow other features characteristic of democratic systems. Free, fair, and competitive elections are only possible if there is some measure of freedom of speech, assembly, and press, and if opposition candidates and parties are able to criticize incumbents without fear of retaliation. Democracy is thus not only a means of constituting authority, it is also a means of limiting authority.

BY ANALYSING FDI IN A macroeconomic framework, this study throws new light on various channels through which FDI can influence saving, investment, growth, and the balance of payments on current account. The first finding is that in a sample of sixteen developing countries, FDI does not provide additional balance-of payments financing for a pre-existing current account deficit. In the eleven developing countries constituting a control group, FDI is associated with reduced domestic investment, so implying that FDI to these countries is simply a close substitute for other capital inflows. For five Southeast Asian developing market economies, however, FDI raises domestic investment by the full extent of the FDI inflow. In these countries, therefore, FDI has not been used as a substitute for other types of capital inflows but has increased capital formation and so worsened the current account.

In examining some secondary effects, I find that FDI has a significantly negative impact on national saving in this sample of developing countries. For the control group, this negative effect is of similar magnitude to the negative effect of FDI on domestic investment, implying a zero effect on the current account. However, the negative effect of FDI on national saving in the five Southeast Asian developing market economies indicates that FDI could have a negative effect on the current account in excess of its negative effect through increased domestic investment.

I also find distinctive differences in the effects of FDI on economic growth in the control group and the Southeast Asian developing market economies. While FDI has a negative effect on growth in the first country group, it has the same positive effect on growth as domestically financed investment in the latter country group.

Finally, for the complete sample of sixteen developing countries, I show that FDI raises the rate of economic growth in the absence of financial repression and trade distortions.

The central component of any model of a modern financial system is the nature of the conduits through which the financial assets of the ultimate savers flow to the liabilities of the ultimate users of finance, both within and between national economies. This involves alternative and competing modes of financial intermediation, or “contracting” between the parties in financial transactions. In this section, we shall discuss the intermediation framework in terms of a model that can be useful in making defensible prognoses of structural shifts in national and global banking and financial markets through time.

A convenient model that can be used to guide thinking on financial contracting and the role of financial institutions and markets is summarized in Figure 2.1. The diagram depicts the financial process (flow-of-funds) among the different sectors of the economy in terms of underlying environmental and regulatory determinants or drivers as well as the generic advantages needed to profit from the three primary intersectoral linkages:

1. • Savings/commercial banking and other traditional forms of intermediated finance.

2. • Investment banking and securitized intermediation.

3. • Various financial direct-connect mechanisms between borrowers and lenders.

Ultimate sources of surplus funds arise in the household sector (deferred consumption or savings), the corporate sector (retained earnings or business savings) and the government sector (budgetary surpluses).

1. • Under the first or “classic” model of financial intermediation, savings (or funds-sources) are held in the form of deposits or alternative types of claims issued by commercial banks, savings organizations, insurance companies or other forms of financial institutions entitled to finance themselves by placing their liabilities directly with the general public. Financial institutions then use these fund flows (liabilities) to purchase domestic and international assets issued by non-financial institution agents such as firms and governments.

2. • Under the second model of fund flows, savings may be allocated directly to the purchase of securities publicly issued and sold by various governmental and private sector organizations in the domestic and international financial markets.

3. • Under the third alternative, savings surpluses may be allocated directly to borrowers through various forms of private placement and other direct-sale mechanisms.

Given the static and dynamic properties of high-performance financial systems and their role in the functioning of the real sector of the economy—as well as the international competitive properties of the national financial systems themselves—how should the prospects of individual financial centres be gauged? That is, based on the foregoing discussion of criteria for high-performance financial systems: (1) in domestic financial intermediation; (2) in competing as a financial centre for value-added services for non-residents; and (3) as a viable home base for financial institutions in their efforts to compete effectively internationally, how do individual financial systems appear to perform? Perhaps a good approach is to begin with a set of criteria such as those provided in Table 9.1, containing the main issues covering the three aspects of financial performance measurement. To illustrate, we shall apply them to the case of Singapore.

As the basis for forming some reasoned judgment on this question, it is useful to outline briefly the salient characteristics of Singapore's financial system and its evolution.

Economic and Policy Environment

The evolution of Singapore's financial sector is profoundly conditioned by the strong economic performance of the country itself and the region in which it lies. Singapore has historically had a very high rate of real economic growth, averaging 8.4 per cent during 1960-90 and attaining 6.7 per cent in 1991 and 5.8 per cent in 1992—a period of comparatively weak global economic activity. Comparable real growth rates were recorded in the remaining ASEAN countries (with the exception of the Philippines) and in Taiwan, South Korea, Hong Kong and China, making the regional market for financial services generated in Singapore the world's most buoyant.

Rapid growth in Singapore and its environs had been coupled to an extremely high domestic gross savings rate averaging 19.3 per cent in the 1970s, 34.2 per cent in the 1980s, and attaining 46.4 per cent in 1992.

The revolution which occurred in the transport system at the end of the nineteenth century, the opening of the Suez Canal, the greater global mobility of populations, progress in printing, and the monetization of colonial economies which benefited certain classes in the periphery, are all factors which can be cited to explain the growing impact of the Middle East on the world of Southeast Asia. These practical factors went hand in hand with ideological ones which encouraged the traffic of ideas, the proliferation of magazines, and the multiplication of student travellers, as well as the flourishing of the Haj industry.

The appearance of these practical factors coincided with the birth of modernist reformist Pan-Islamism advocated by al-Afghani and ‘Abduh, which attracted a vast audience in the Southeast Asian world.’ Pan-Islamism was not only a political movement, but it also had a material impact on education in both Egypt and Indonesia. It led, for example, to the explosion of magazines, and the expansion of the market of Islamic writings. In both Egypt and Southeast Asia, reformist ideas also played a significant role in shaping nationalism.

The impact on Southeast Asia of modernist ideas at the beginning of this century, the widening circulation of magazines, and of networks created in the field of education, the press, and literature have been widely analysed by Noer (1973), Boland (1971), Roff (1967), and Mohamed A. Zaki (1965). William Roff (1970) has pointed to the significance of Cairo for Indonesian and Malay students in the 1920s, who later held important positions in the religious sector. He observed that their number increased as a result of both economic and political reasons. Their number continued to grow, in particular after independence and more than tripled in the period of the seventies. Cairo during colonial times, and particularly in the 1920s, provided a fertile ground for the Southeast Asian students to express freely their anti-colonial sentiments. This, we are told, was the main reason why they preferred Cairo to any other place (Roff 1970, pp. 74-84).

The first section of this study was intended to do the following: (1) Set forth an intuitive model of national and international financial intermediation capable of capturing each of the functions involved in the process, as well as measures of static and dynamic efficiency; (2) Suggest strategic positioning alternatives facing banks and other firms engaged in the financial intermediation process; (3) Identify the principal determinants of competitive performance of financial firms; (4) Consider issues relating to the regulatory overlay, particularly stability versus efficiency, and the impact of regulatory structures on financial system performance; and (5) Review the alternative structures financial firms may choose to adopt, how these in turn relate to bank-industry linkages and the process of corporate control, and ultimately the dynamics of financial market development and national economic performance.

All of these issues are important in determining the competitiveness of national financial systems. Competitiveness, in turn, can be framed in terms of static and dynamic efficiency properties, discussed earlier, with static inefficiency and lack of creativity driving financial transaction streams abroad. High performance financial systems, on the other hand, may attract transactions from other financial systems, where costs or the net regulatory burdens are higher, and form the basis of an export-oriented engine of economic growth. Consequently, rigorous competition among financial services firms has increasingly been joined by equally rigorous competition among financial centres.

It should be clear from the earlier discussion that the financial services sector has grown and changed far more rapidly than many others in the world economy in recent years. Today it is one of the most structurally complex and dynamic industries in existence. It is also one of the most heavily regulated—owing to the fiduciary nature of many of its activities, its pivotal role in the execution of money and credit policies, as well as its susceptibility to recurring crises.

The remarkable revolution in this industry has created intense competition among banks and other financial services firms around the globe, as well as among the financial centres in which those firms are based and in which they operate.

The world is undergoing dramatic transformations in the wake of the crumbling of the Cold War order, and the ebbs and flows of these changes are not passing unnoticed in Southeast Asia. Indeed, the region is witnessing its own mini-versions of glasnost and perestroika, as countries like Vietnam, Cambodia, Laos, and Myanmar, for instance, seek their niches in the emerging opportunities and constraints that characterize the international economic and political scene. This, coupled with the dynamism of the member states of ASEAN, makes Southeast Asia a particularly promising and exciting area – at a turning point in world history and human affairs. These developments have reinforced a growing awareness at the Institute for the need for a publication produced in and from the region and devoted exclusively to the geo-politics and geo-economics of Southeast Asia. Accordingly, the Institute inaugurated Regional Outlook last year.

Cast in a format and style that is unencumbered by lengthy analyses or commentaries, Regional Outlook provides succinct yet substantive and easily readable overviews and insights into the current geo-political and economic situations in the individual countries and the region as a whole, together with the likely trends over the next year or so. The Institute very much hopes that the review will serve as a useful and handy guide to the region's aspirations and prospects each year, in addition to casting a look ahead.

It is thus all the more pleasurable to wish Regional Outlook and the individual contributors all the best, as well as express the hope that Regional Outlook will circulate widely among all interested in the affairs of the region, and especially so among the busy executives, and other decision-makers in both the public and private sectors. In recording these expectations it is, of course, understood that responsibility for facts and opinions expressed in the review rests exclusively with the individual authors, and their interpretations do not necessarily reflect the views or policy of the Institute or its supporters.

A useful way to visualize the competitive opportunity set that faces banks and other financial firms operating across the spectrum depicted in Figure 3.1 combines three principal dimensions in the delivery of financial services in terms of the clients served (C), the geographic arenas where business is done (A) and the products supplied (P) (Walter 1988). Figure 3.1 depicts these dimensions in the form of a matrix of C-A-P cells.

Individual cells represent a more or less distinct “market” in which Euroclear either is already active or might become active. The characteristics of each potential market can be analysed in terms of conventional competitive structure criteria. The competitive structure of each C-A-P cell is an important determinant of the excess returns a financial institution may be able to obtain. To the extent competition takes place on the basis of price, prospective returns are transferred to clients. Competitive structure is conventionally measured using concentration ratios based on the number of vendors, distribution of market share among vendors, and similar criteria.

The inherent attractiveness of each cell clearly depends on the size of the prospective risk-adjusted returns that can be extracted from it. The durability of these returns will depend on the ability of new players to enter the cell, as well as the development of substitute products over time. Entry into a new market (associated either with a new product, client-group or arena), if initially successful, can be described in terms of a time-path of sub-normal, super-normal, and normal returns such as that depicted in Figure 3.2. This time-path is important with respect to the entry costs, exit costs, as well as size and durability of excess returns. Durability is described by the time-path (decay) of excess returns that can be extracted from the new market in this context, and their discounted net present value can be compared with those other market initiatives including transfers of financial innovations across clients, arenas or products.