Emerging markets Vs foreigners

Nationalization may be passé, but confiscation is not. Foreign corporations are no longer considered necessary to economic growth in emerging markets and are not welcome

When I was growing up in the 50s and 60s we had third world countries. Many of these countries had just won their independence from their colonial masters. Independence movements were often led by idealistic leaders inspired by the communist revolutions in other countries. These young nations had just rid themselves of a society made up of natives and masters. The humiliation of this two-tiered system made the attraction of socialism with equal division of wealth irresistible. Sadly it didn’t work.
New countries without reliable institutions are inherently unstable. To solidify gains, leaders empowered a new class of elites, loyal only to the new regime. In countries that were supposed to be ruled with egalitarian ideals, all citizens were equal, but some citizens became more equal than others. Like all other elites before them, this new class armed with the tools of an increasingly bureaucratic state went about rent seeking, often with reckless abandon.
Rent seekers by their very nature have an enormous economic incentive to increase their take. Since they were the government, there were not the legal limits that usually are sufficient to muzzle political ambitions and pillage. But in poor countries, often taxes were not enough. The combination of socialist ideals and anti-colonial sentiment made foreign corporations a logical and natural target. The local assets of colonial corporations were nationalized by the score and the party faithful were given privileged positions running the companies.
The heady cocktail of government control, xenophobia, and incompetence was an economic disaster. After 20 years of independence many of these countries had not experienced any growth at all. Something else had to be tried.
What was tried was known as the Washington consensus. This was combination of policies that are painfully obvious, but are very hard for countries to swallow. The list includes fiscal discipline, the end to subsidies, tax reform, trade liberalization, encouragement of foreign direct investment, deregulation, privatization of state industries and protection of property rights. What is hard to swallow about these reforms is that they rescind many of the elites’ privileges and protected status. No one likes to lose economic power. For this reason reform in every country anywhere will meet massive resistance, regardless of whether the privileged are Wall Street bankers, French civil servants or Communist Chinese cadres. But these poor countries had little choice, so they reformed.
The economic revolution that took place starting in the early nineties was in many ways as dramatic as the earlier political ones. From the creation of special economic zones in Shenzhen, China, to the end of the License Raj in India, reforms spurred fantastic economic growth. Massive bureaucratic red tape was reduced; foreign investors were aggressively courted; state firms were sold off. In a few short years the third world became emerging markets. Their rapid economic growth was the envy of the sclerotic and debt-burdened developed world. They were on a trajectory of limitless growth. Or not.
Success always breeds arrogance. Emerging markets are no different. Economic reforms did not evolve into political reforms. The elites were still around and learned something very important. There was much more to steal in a successful economy than in an unsuccessful one. They began to understand it was much better to take a larger share of the income stream than the asset.
One of the most obvious areas is natural resources. Foreign capital and expertise are invariably necessary to coax riches from the ground, but recent high prices from the commodities boom have made profits from extraction irresistible. Demands for higher taxes and royalties are increasing in countries from Venezuela, and Argentina, to Indonesia and even Mongolia. Resource nationalism has replaced capital allocation as the number one concern of executives.
Nationalization may be passé, but confiscation is not. It is just done with more finesse. A former Indonesian general and potential presidential candidate was able to take over a giant coal deposit claim of a British company by alleging that lapsed licenses were still in force and had priority. When Russia wanted to muscle out Shell from its find off Sakhalin Island, they brought charges of environmental violations. The successful Russian oil company Yukos was stolen by a claim of unpaid taxes. The most recent Indian draft budget contains a retroactive tax aimed at Vodafone, the second largest telecom operator in India. The tax would reverse an Indian Supreme Court decision that should have settled the case. In China a prominent talk-show host wants to “throw out the foreign trash”. Foreign corporations are no longer considered necessary to economic growth and are not welcome.  
Economists like to ascribe the miraculous growth of emerging markets to things like demographics which would make continued growth inevitable. It’s not. The rapid growth of emerging markets is only as strong as the laws that created the reforms and those laws are only written on paper.  

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)

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