When looking for investment, democracy really does matter

Buenos Aires Herald. 10 de mayo de 2016.

The government of Mauricio Macri is actively seeking to promote investment from abroad. This includes foreign direct investment as well as loans (hopefully at low interest rates) from private sources and from international financial institutions. The idea is to stimulate the economy, generate jobs, and improve the country’s infrastructure, thereby promoting long-term development.

What can governments do to attract foreign investment? There are short and long term factors to consider.

In the very short term, leaders may wish to entice investors with quick and easy benefits such as high interest rates or temporary tax breaks. However, in the long and medium term, the credibility of the country´s investment and regulatory regimes will matter far more.

Political scientists, economists, and business scholars have known for some time that politics can play a major role in providing credibility for investment decisions. This starts at the level of the national political regime. Although there certainly may be exceptions, countries that have well-functioning democratic institutions are less likely to engage in dramatic expropriations or restrictions on capital flows, and to have generally better enforcement of contracts. Improvements in democracy, such as a more programmatic party system, would serve the long-term interests of investors and citizens alike. However, even a genuine commitment to democratic reforms would not produce the immediate and visible investment payoffs the government seeks.

A smaller version of the same dynamic applies to the regulatory environment for investment or for particular sectors, and is more immediately applicable. To illustrate this point, it can be instructive to consider, in historical and political context, the government´s new emphasis on Private-Public Partnerships (PPPs), which range from simple concessions to private sector actors for the construction of infrastructure or the provision of public services to more complex schemes in which firms agree to hand control back to the state after a pre-determined period of time.

During the 1990s quite a few governments implemented privatization programs, especially for the provision of “public goods,” such as infrastructure, and “public services,” such as energy or telecommunications. Privatization promised the double benefit of the money from the sale and improvements in service. In some cases the expected benefits were achieved, but too often the result was disappointing.

Hasty decisions, made under difficult conditions (e.g., when governments are desperate for investments) were one of the reasons for the bad public policy consequences. Regulations were rushed and poorly designed, and therefore promises of investment were not kept. All the public noticed in some cases was the higher prices resulting from the end of state subsidies.

To avoid the mistakes of the past, it is important to consider the democratic process by which governance decisions about PPS and other forms of investment are made. Reforms may proceed more slowly, but a higher level of political legitimacy will be worth it in the medium to long term.

In addition to being more legitimate, a more deliberative process can produce better regulatory outcomes. With more time and debate, international best practices and benchmarks can be incorporated, not in a blind way, but in one adapted to the local context. For example, the careful selection of initial pilot projects (a recommendation of the International Development Bank for PPPs) is more likely to reflect the country´s real infrastructure priorities if it is supported by a genuinely broad political coalition.

To conclude, it is possible to learn something from scholarship on investment, from Argentina´s past, and from international experience. There are many economic and technical matters to consider, and some are more important than others. This column has argued that, politically speaking, the major lesson is that democracy does matter. The key to long term success is the construction of transparent regulatory regimes with a high level of consensus through a deliberative process.