How foreign capital can hinder economic development

Towards good globalisation

How do some countries manage to channel foreign capital into economic development while others are just exploited by it?

https://aeon.co/essays/how-foreign-capital-can-hinder-or-help-economic-development


The Volkswagen plant in São Paulo, Brazil in 1990. Photo by Gérard Sioen/Gamma-Rapho/Getty



In Nigeria’s oil fields, international giants have pumped crude for decades – yet the country struggles to develop its own refineries or high-tech industries. In Mexico, global car companies churn out vehicles for export, but local suppliers and engineers remain stuck making low-value parts. Stories like these reflect a troubling pattern across the developing world: foreign capital pouring in, while domestic capabilities stagnate or even erode. Policymakers in poor and middle-income countries are often told that attracting foreign investors is key to prosperity: inflows are treated as a ‘vote of confidence’ and their decline as a sign of distress. According to this dominant narrative, capital naturally flows to places where it’s needed most, bringing not just money but advanced technology and managerial expertise in its wake. By this logic, if investors hesitate to come, the fault lies in the host country’s policies or politics. In our era of globalisation, foreign investment is heralded as a lifeline for developing economies – a reflection of economic strength and a driver of future growth.

Yet history tells a more complicated story. Some of the world’s most successful economies rose to prosperity by keeping foreign capital on a tight leash. South Korea and Taiwan, for instance, leveraged foreign money and know-how on their own terms, ensuring it aligned with national priorities. Even the United States and Japan – today’s wealthy giants – were once very cautious about foreign investment on their soil. The US was one of the largest recipients of foreign capital in the 19th and early 20th centuries, but it imposed strict rules on foreign investors, especially in banking, shipping, natural resources and other strategic sectors. Japan went even further, tightly regulating foreign business to protect and nurture its domestic industries. These countries didn’t simply throw open the doors. This historical lesson suggests that, while foreign investment can be a tool for development, it works only when a country retains control over how that capital is used and ensures the benefits are captured at home.

Beginning in the 1980s, however, a different approach to foreign capital took hold across much of the Global South. Influenced by a resurgence of free-market ideology, Washington institutions – in particular the IMF and the World Bank, backed by the US Treasury – urged (and often pressured) developing countries to ‘liberalise’ their economies: privatise state industries, deregulate markets, cut tariffs, and welcome multinational corporations with open arms. Sir Leon Brittan, a former European trade official, captured the era’s optimism in 1995 when he proclaimed that investment was finally ‘recognised for what it is: a source of extra capital, a contribution to a healthy external balance, a basis for increased productivity, additional employment, effective competition, rational production, technology transfer, and a source of managerial know-how’. In other words, foreign capital was seen as an unambiguous good – a panacea for development.


The US trade representative Mickey Kantor signing the final measure of the Uruguay Round of the General Agreement on Tariffs and Trade in Marrakech, 1994. Photo © WTO

Under this gospel of globalisation, international agreements were also locked in a kind of one-size-fits-all openness. In the 1990s, the Uruguay Round created the World Trade Organization (WTO), a club of governments that writes common rules for trade and runs a court-like system to settle disputes. Two of its agreements mattered a lot for foreign investment. First, the Agreement on Trade-Related Investment Measures (TRIMs) says countries cannot use certain investment conditions that interfere with trade in goods. The most well-known example was the practice of demanding that foreign firms buy a set share of inputs (the parts, raw materials and services it needs to produce) from local suppliers (‘local content’). Other common demands, like making a foreign company partner with a local firm (a joint venture) to promote technology transfer, are not directly banned by TRIMs. In practice, however, they’ve become harder to sustain because firms can challenge them as discriminatory or as back-door restrictions on imports. Second, the General Agreement on Trade in Services (WTOS) sets the rules for services such as banking, telecoms and transport. To participate fully in GATS, a developing country generally cannot cap foreign ownership or require joint ventures.

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