26 August 2021 Written by  TESFAYE ABATE

THE LIBERAL CONSENSUS THEORY ON FOREIGN DIRECT INVESTMENT

 

Liberal economic theory is based on the premise that free-market yield maximum productivity. In the eighteenth century, Adam Smith and David Ricardo came up with the liberal economic theory and challenged mercantilism. Mercantilism argues that extensive state regulation of economic activity is necessary to promote the interest of a nation. In the period between the 16th to 18th centuries, mercantilism was a dominant political-economic theory in Europe. According to mercantilists, a national wealth may be equated with the quantity of gold held hold by the state. Hence, they sought to restrict imports and increase exports to increase the gold supply.

 

On the contrary, according to liberalists, the wealth of the national economy could not be equated with the amount of gold in the treasury; rather national wealth is best measured by the productivity of the people. They further argued that the productivity of people is best achieved by an unregulated market. Liberals opposed restrictions on national trade. Liberalism propagates for a free market economy.

 

In 1947, the establishment of the General Agreement on Tariffs and Trade (GATT) heralded the coming into being of sustainable liberalism. In the nineteenth century, industrialization bloomed. It was possible to produce large capital surpluses, and this in turn makes the capital available for investment. Large manufacturing and transportation enterprises that were developed required major capital investments. In the nineteenth century, most of the investment was portfolio investment. For example, the investment was made in securities because the securities market emerged. In short, the boosting of investment necessitates a free market economy because it is a free market economy that promotes investment.

 

The contemporary consensus emerged as a result of debates due to economic nationalism prevalent in the 1990s. Nowadays, it is believed that economic development requires increased productivity and equitable distribution of wealth. Hence, “sustainable liberalism requires that a liberal investment regime provide some measures of both growth and equality”.

 

In the 1980s developing states were unable to pay their debts to their creditors. In turn, banks were unwilling to finance (through loans) to the economy of developing states. Thus, foreign direct investment was taken by developing states as a means of making capital available. In addition, the collapse of the Soviet Union necessitated a free market economy. Hence, the emergence of consensus requires not only free-market economic policy but also competing for it.

 

In general, liberal economic theory is based on the premise that free markets will yield maximum productivity. This could work only where markets are functioning well. However, markets fail in developing countries. In such a case, a state is required to intervene to correct serious market failure. Developed states should also provide assistance, such as technical assistance with regard to the development of legal institutions and economic assistance.

 

QUESTIONS

 

  • Analyze the relevance of the General Agreement on Tariffs and Trade (GATT) to investment.
  • Discuss how the contemporary liberal consensus emerged.
  • Analyze how a free market economy would promote investment.
  • Discuss the role of developed states in promoting investment in developing countries.

 

 

Last modified on Thursday, 26 August 2021 15:39