Development Impact of U.S. Investment in Less Developed Countries

Published by the Government Accountability Office on 1971-09-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                       I        *     03
                                                    a.0. -*             /

                            UNITED STATES GENERAL ACCOUN
                                    WASHINGTON,      D.C.     20


           B-173240                                                         SEP 24 1!3”$%


          Dear Mr. Mills:

                  The General Accounting Office has made a study of the
                   i---:L-             U.S. investment in less developed
          countries       under the investment insurance program formerly
           administered      by the Agency for International   Development and '
           now by the Overseas Private Investment Corporation          (OPIC).    '
           Investment insurance is the most significant        of several pro-
           grams now being administered        by OPIC for encouraging   the flow
           of new development-oriented        U.S. investment to less developed
                Our interest     in the development aspects of this program
           stems from the stress placed by the Congress on the need for
           the activities    undertaken by OPIC to be development oriented.
           The recent legislation      establishing    OPIC states that OPIC is
           II         to encourage and support only those private        invest-
           ment; in less developed friendly         countries  and areas which
           are sensitive    and responsive     to the special needs and require-
           ments of their economies and which contribute          to the social
           and economic development of their people; . . ."
                 Our study relates     to insured investment in extractive
           and manufacturing    industries    in the less developed countries.
           Insured investment in these industries        has accounted for about
           77 percent of total     insured investment.     In our study we focused
           on the impact of insured investment on employment, efficiency,
           exports,  and stimulation      of the growth of local industry.     While
           these are not the only ways of measuring developmental          impact,
           they are important factors       in deciding whether insured invest-
           ment may benefit   less developed countries.

                                  50 TH ANNIVERSARY         1921.1971



              ,The results   of our study, although based upon limited
        available   information,    did indicate   that the investment        insur-
        ance program had had varied impact in stimulating            development
        in the less developed countries.         We are attaching,     for your
        information    and consideration,    a summary of what we found, with
        the hope that it will assist OPIC in the efforts           it is report-
        edly making to develop sensible and workable criteria             for
        assessing the development impact of the investment insurance
        program.    We would be happy to discuss any of these matters
        further with you or your staff if you wish.
                    We recognize,    of course, that investors      are primarily
            motivated by considerations        of profitability     which may not
            coincide with development considerations            and that the U.S.
            Government has less influence         over privately    financed projects
            than those which it finances.          Hence, we can appreciate       the
            views of OPIC officials       that their choice is not whether a
            proposed investment offers maximum development impact to the
            less developed country,       but rather to decide whether the par-
            ticular     mix of returns-- to the less developed country,          to the
            investor,     and to the enterprise     concerned--on     balance offers
            significant     constructive    development impact in and of itself.

                  We wish to thank you and your staff for the cooperation
            extended to us during the course of our review.

                 Copies of this letter   are being sent to the Administrator,
            AID (Chairman, Board of Directors    of OPIC), the Director?   Office
            of Management and Budget, and the Foreign Operations and Govern-
            ment Information  Subcommittee of the House Government Operations,            ,.

                                                       Sincerely   yours,

                                                       f ~QJA 3,ia c\<-
                                                                     \ o-.
                                                       Oye V. Stovall
            Mr. Bradford Mills
            President,  Overseas Private          ,.
              Investment Corporation
.    .


               Some Factors For Consideration  In Assessing
                    Development Impact of U.S. Insured
                 Investment in Less Developed Countries

          The recently    published   Pearson Commission Report        concluded:
                "The failure to create meaningful employment is
          the most tragic failure   of development.    All indica-
          tions are that unemployment and under-utilization       of
          human resources have increased in the 1960's and
          that the problem will grow even more serious. I! h/

            As an example of the magnitude of the employment problem,
    the Economic Commission for Latin America has estimated that
    about 30 percent of the labor for       (economically active popu-
    lation)    is un- or underemployed. -59
          The incidence of unemployment is chiefly  on unskilled  labor.
    While unemployment of unskilled  labor is large and increasing,
    there is at the same time a shortage of skilled   labor in less
    developed countries.
         One of the major reasons for increased unemployment has
    been that industrial   growth in the LDCs has been concentrated
    in the more capital  intensive  industries. a/

            For this reason, GAO has evaluated the employment impact of
    previously-insured       investment in terms of whether investment
    went into activities        which are relatively     capital    and skilled-
    labor intensive       (which will be referred      to as capital     intensive)
    or into activities       which are unskilled     labor intensive       (which
    will be+?referred to as labor intensive).            For  purposes     of  this
    evaluation,     capital    intensive  industries    are defined to be
    those industries       where value added (value of production           minus
    cost of inputs purchased from other industries)               per employee
    exceeds the average (median) value added of the entire sector
    ( i.e.,   manufacturing,      mining, or manufacturing       and mining
    combined) in the United States and labor intensive               industries

    11 Pearson, L.B., Partners in Development, Report of the Commission
    on International Development, Praeger Publishers, New York, 1969, p. 58
    a Economic Survey of Latin America, 1968, Economic Commission for
       Latin America, 1969 (Dot. E/CN.12/825).
    2/ Dziadek, F., Unemployment in the Less Developed             Countries,   AID
       Discussion  Paper No. 16, June 1967.
  'are those where value per employee is less than the average
   (median) value added per employee for the entire sector in
   the United States.   This methodology is based on a recent
   study of LDC manufacturing   exports which shows that value-
   added per employee is a good measure of capital    intensity
   and that there is an international   similarity in the ranking
   of industries  by degree of capital  intensity. 11

          The results      of our investigation     are shown below:
                                                      Percentage of insured
                                                      investment relatively
                Insured investment                       labor intensive
            Mining and          Manufac-              Mining and         Manufac-
Year       manufacturing       turing only           manufacturing        turing
1961      $ 41.6 million          $ 12.9 million              1                 1
1965       181.5 million           159.5 million            21                 14
1969       458.1 million           244.1 million              7                 9
          Itis clear that insured investment has gone into the more
   capital  intensive  industrial activities. It would therefore
   appear that employment returns from U.S. investments have been
   limited.  21

          Industrialization       is a key to improving the economic
   status of many of the less developed countries,                  and consequently
   a number of strategies         have been adopted by them to promote the
   establishment       and expansion of industrial         activities.       A major
   problem, however, in fostering          industrialization           that has plagued
   many industrial        promotion programs is that the industries             esta-
   blished may be economically         inefficient;       that is, the goods pro-
   dueed by these industries         may be significantly          more costly than
   if they could be purchased in the world market.

   L;/ Lary,    H.B., Imports of Manufactures from Less Developed Coun-
       tries,    National Bureau of Economic Research, New York, 1968.

   2/ CA0 recognizes     that     the measure used is only one, albeit,
      important   indicator       of the employment impact of U.S. foreign
        It might be argued that in the context of a less developed
country,    cost considerations       especially    those of domestic
resources are not important.           Apparently,     this argument is based
upon the characterization        of a less developed country as a labor
surplus economy. However, it ignores the fact that production
in less developed countries         involves a significant         use of scarce
( i.e.,   expensive)  factors    of   production.      These  include   imports,
domestic capital     and skilled      labor.     The generalization     that
labor is plentiful     most certainly        does not apply to skilled       labor.

       The efficiency     of insured investment projects may be gauged
by comparing the cost of production       associated with insured invest-
ment projects     in less developed countries with the cost of produc-
tion elsewhere.      Unfortunately,  the data for maki;$ s;;trzs;;s.ments
of insured investment projects were unavailable.
have not been any studies covering a large number of LDC's, on the
comparative cost of U.S. investment (i,e.,         insured and non-insured).

       It  is not possible to determine from the available       evidence
whether insured investment has been efficient     (i.e.,    costs of
production    from insured investment in less developed countries
are reasonable relative    to costs of production   elsewhere).      The
evidence, however, does suggest that efficiency      requires special
attention    by OPIC.

       A recent study of industrial  development in seven LDC's
concluded that there has been high cost, as well as efficient
foreign investment in these countries.   2/

        We examined a number of studies that compare costs in LXX's
to foreign costs of production.     These studies reveal that many
industries   in LDC's are high cost relative    to the world market. A/

L/ Responses to OPIC's new questionnaire            may permit     such assess-
   ments of proposed insured investments.
2?./ I. Little,   et.  al., Industry and Trade in Some Developing Coun-
     tries,    OECD, Oxford University Press, New York, 1970, pp. 58-59.

2/ Bela Balassa and Associates,         The Structure  of Protection   in
   Developing Countries,       preliminary   study sponsored by the
   International      Dank for Reconstruction     and Development and the
   Inter-American      Development Bank; airgram for Turkey AID Mission
   dated 10/31/68 discussing        the cost of Turkish industry;    and
   Little,    op. cit.
        One study covers the manufacturing   sector in some detail
in five LDC's for which there are insurance programs - Brazil,
Chile, Pakistan,    the Philippines, and Western Malaysia. J./
With the exception of one country,     it appears that insured manu-
facturing   investment in these countries   has located in industries
which are high cost. 21 The following      schedule summarizes each
country's   performance:

                                            Percent of insured

           Brazil                                      85
           Chile                                       71
            Pakistan                                   42
            Philippines                                87
           Western Malaysia                             0
   Balassa, op. cit. The cost data for Brazil,  Chile, Pakistan,
   the Philippines,  and Western Malysia are for 1967, 1961,
   1963/64, 1965, and 1965, respectively.
   The product groups used in the study are broader than the
   industry    categories    by which investment is classified.
   Therefore,     the correspondence       of the investment figures
   with their respective        product groups is only approximate.
   Thus, the level of aggregation           in the study's data may con-
   ceal differences       in relative    costs for individual     industries
   and companies.       Some insured investment could not fit into
   any of the product groups identified            in the individual
   country chapters of the study.            We therefore   omitted such
   investment.      Except for the Philippines,         the amounts
   excluded were relatively         small.

        During the course of our review, the Agency for Inter-
national    Development retained a consultant   to propose criteria
for determining    whether potential  insured investment is likely
to lead to high cost production.      It is our understanding     that
his proposed guidelines     have been adopted by OPIC.


       Exports are important for the development of LDC's for
several reasons.     They permit a country to earn foreign exchange
for purchasing vital    imports of goods and services which may
not be able to be produced domestically      in sufficient      quantity
and at reasonable cost.      They are a good indicator       of the extent
to which domestic goods are produced efficiently;          if a signifi-
cant proportion    of a country's  output is sold abroad, it is
likely  that domestic costs for products it exports are reason-
able because exports generally     must be priced competitively
with those of other countries.       Also the quality    of domestic
output is likely    to be high because exports in general must
compete in quality    as well as in price with the exports of
other countries.

        Replies to a joint AID-GAO sample survey of insured
investors    show that exports of insured U.S. manufacturing            affi-
liates amounted to 10 percent of total sales in 1969-70.                However,
if intra-company     exports, which frequently       represent   transactions
at non-market prices are excluded,          the export proportion       of
insured investment declines        to 5 percent.     The survey also shows
that only 25 percent (12 percent excluding           intra-company     exports)
of insured investment was in manufacturing           activities    which
generated exports amounting to 10 percent or more of total sales.
Therefore,    it is doubtful    that U.S. insured investment in manu-
facturing    has a satisfactory     export orientation.       L/

        There were few responses to the survey by insured extractive
industry   affiliates.  As a proxy, we used Department of Commerce
data, which cover both insured and uninsured extractive   investment
I/   There appears to be an improvement in export orientation              between
     1957 and 1966.     Department   of Commerce     data   shows  the  export
     proportion   of U.S. manufacturing    affiliates       in Latin America,
     including  intra-company    sales, increasing       from 4 to 10 percent.
     Since the 1957 data do not separate intra-company             sales, a
     comparison net of intra-company      sales is not possible.
in Wtin    America  for 1966.  Much of U.S, direct extractive
industry   investment in Latin America appears to be insured.
Moreover, insured extractive    industry   investment in Latin
America is a large proportion     of total insured investment in
 this sector in all LDC's.

        In 1966, exports of U.S. extractive      affiliates   in Latin
America were 65 percent of total sales.      11      If company sales
are excluded,    the export proportion  declines to 41 percent.
Therefore U.S. investment in extractive       industries    has a good
export orientation.

      U.S. foreign investment may make an important contribution
to the development of less developed countries    by stimulating
the growth of local industry.     One way in which it can do this
is by spending on locally   produced goods and services.
       Replies to the previously    mentioned joint AID-GAB sample
survey of insured investors    indicate   that insured U.S. manufactur-
ing affiliates  have spent a significant      amount on locally produced
goods and services.   In 1969 - 70, local purchases amounted to
44 percent of their total sales.

         There were few responses to the survey by insured extractive
affiliates.     As with  exportss as a proxy we used Department of
Commerce data, wh%ch cover both insured and uninsured extractive
investment in Latin     America  in 1966.

        Although the relative      amount of local purchases are lower
than for manufacturing     affiliates,    we conclude that U.S. extrac-
tive affiliates   have spent a significant       amount on locally    pro-
duced goods and services.         In 1966 local purchases of materials,
supplies and services of U.S. extractive         affiliates  in Latin
America amounted to 29 percent of their total sales.
t/   These results    include manufacturing   as well as the mining
     aspects of petroleum industries.       Only the former category
     is eligible   for AID insurance with limited coverage avail-
     able for the exploration    and production   aspects of petroleum
     mining investment.

        *U.S. foreign investment may also stimulate     the growth of
local industry      by encouraging local participation    in the manage-
ment of the enterprises       into which U.S. investment enters.
Local participation      in the management of U.S. foreign affiliates
is also important because it helps to reduce nationalist         sensi-
tivities     to foreign investment.

       One measure of the extent to which insured investment has
encouraged local participation   is the proportion of local equity
in the total equity of U.S. imsured affiliates.    A tabulation
of the usable results   from the joint AID-GAB sample survey shows
the following:

           % Local Equity               Number of Insured    Projects

                  0                                  29

                1 - 24                                5

               25 -   49                             I.6

               50 & over                            22

         It is clear that local equity participation        in U.S. financed
ventures has been low. A salient         feature is the relatively     large
number of firms reporting       no local equity participation.      In this
connection,    it is interesting     to note that the President's     task
force on International      Development recommended that QPIC make
greater use of its guaranty programs to encourage local equity