The controversial case of Rio Tinto and politics in Serbia
Arguments, pro et contra
This is a small contribution to the ongoing discussion about the role of foreign direct investments (FDIs) and the state of accumulation in Serbia. The two sides of this very interesting (and evergreen) discussion are represented by Prof. Ljubomir Madžar (https://novaekonomija.rs/vesti-iz-zemlje/srbija-ne-mo%C5%BEe-da-se-razvija-samo-stranim-investicijama and NIN broj 3693/7. oktobar 2021) and Dr. Miladin Kovačevič, Director of the Statistical Office of Serbia (NIN broj 3694/14. oktobar 2021).
FDIs is one of those evergreen topics that has been discussed since the institutionalization of development economics in the 1950s-1960s. The current discussion in Serbia recently rekindled by the Rio Tinto lithium mining project represents two schools of thoughts that has formed since the beginning of discussion: one that believes in the positive development impact of FDIs; the other that insists on negative consequences of FDIs for indigenous development.
The traditional economic approach represented by Dr. Kovačevič argues that FDI is a net addition to investible resources in host countries, and as such raises their rates of growth as well as leading to ancillary advantages to the recipient economy. The reasoning of this approach is rather straightforward. The value of FDI is in that it covers the “savings-investment gap” that prevents countries from development (that is, the difference between a country’s own investment capital, or level of national capital accumulation, and the level of capital required for its growth).
The basic Harrod-Domar growth model (named after two American economists), the workhorse of economic analysis, postulates a direct relationship between a country’s net savings ratio, s, and its rate of output growth, g, via the equation g = s/c, where c is the national capital-output ratio. Hence, if the desired rate of national output growth, g, is targeted at 7% annually, and the capital-output ratio is 3, the needed rate of annual rate savings is 21% (because s = gc). If the saving that can be domestically mobilized amounts to only 16% of GDP, a “saving gap” equal to 5% can be said to exist. If the national can fill this gap with foreign financial resources (either private or public), it will be better able to achieve its target rate of growth. Simple and neat.
In principle, there is nothing in this approach that would limit the share of FDIs in the investment capital mix. Obviously, hardly any foreign investor would invest in a country that invests nothing in its own development but the share of FDI may vary within a very broad range, essentially determined by the foreign investors’ risk and return profile as well as the investment climate and opportunities in the recipient country.
The anti-FDI approach particularly its nationalist variety, argues that FDI damages the host economies through the suppression of domestic entrepreneurship, importation of unsuitable technology and unsuitable products, the extension of oligopolistic practices such as unnecessary product differentiation, heavy advertising, or excessive profit-taking, and the worsening of income distribution by a self-perpetuating process which simultaneously reinforces high income elites and provides them with expensive consumer goods. The nationalist variety is closely related to the dependence approach, which posits that the inherent dependence status which FDI brings can never permit real development in host countries. Thus, FDI is seen as a link between the centers of the world economy and its exploited periphery.
Capital accumulation in Serbia: What is the dispute about?
This is the essence of Prof. Madžar argument. He claims that Serbia’a net investments in fixed assets (gross fixed capital formation, GFCF, less depreciation) has been about zero or even slightly negative, that domestic capital accumulation doesn’t exist and that foreign capital is given undue preference at the expense of domestic capital whose contribution to gross fixed capital formation becomes negligible. Here’s what he says. As Prof. Madžar argues, the investments in fixed capital formation in Serbia over the past decade or so have been at below 20%. With amortization of 15% and the balance of trade deficit of about 6%, domestic private investments are close to zero, which is totally unsustainable. Nothing less than “Sodom and Gomorra” is happening in Serbia where, in the words of Prof. Madžar, the government is committing a “mortal sin” by increasing average wages in the public sector and pensions and promoting unsustainable pattern of consumption at the expense of saving and accumulation. He concludes: “Development without domestic accumulation is a strategic retreat, a boat without the rule and oars, a pan without the handle”.
Dr. Kovačević argues that the pattern of low domestic accumulation described by Prof. Madžar was valid in the period between 2000 and 2012 but not later. With the financial consolidation of 2014, Serbia managed to achieve a level of macroeconomic stability that has made it attractive for FDIs from around the world estimated at $3.8 billion in 2021. Kovačevič insists that FDI played a critical role in ensuring higher saving rates (domestic accumulation) by investing in capital project sand creating more jobs in 2000-2014. Domestic savings picked up since 2014 based on a new growth model and principles of economic, monetary, and fiscal policy. Dr. Kovačević also points out that the division into “domestic” and “foreign” companies doesn’t make sense in a progressively globalizing world since a company making business in Serbia has to be a resident company regardless of the participation of non-resident capital and that free flow of capital is one of the defining features of modern economy, particularly in the EU context.
This discussion has two features. Firstly, it has become politicized pitting two camps against each other: pro-government who support the government policy to invite more FDI and anti-government, those who see this policy detrimental to Serbia’s longer-term development interests. To complicate things further, the discussion uses the term “accumulation” in at least three meanings: as capital accumulation (that is growth in fixed capital assets), savings accumulation (that is accumulation of private financial capital that can be invested in capital assets), and the investment capacity of the domestic private sector (investible funds of domestic enterprises determined by a combination of technical, financial and some other factors).
Let us unpack the first use of accumulation since there isn’t such a term as accumulation in the system of national accounts. What Prof. Madžar says about accumulation in the sense of the growth of capital assets boils down to net domestic investment, which is the part of gross investment that adds to the existing stock of structures and equipment inclusive of both private (domestic and foreign) and government investments. In terms of the system of national accounts, this is gross fixed capital formation (including both private and government fixed investments) less consumption of fixed assets (their depreciation) less imports included in the investments (represented by the share of capital goods in BOT).
Regional and national statistics: What do they say about Serbia?
A comparison of regional statistics for the variables in this formula doesn’t show any significant differences between Serbia and the other countries in the region (Bulgaria, Croatia and Hungary). Figure 1A shows that Serbia’s GFCF rates have not been excessively low compared to the other countries in the region. It is 4-6% below Hungary, the regional leader, on par with Croatia and ahead of Bulgaria (in the past 3 years). Nor is Serbia overly dependent on FDI compared to the other countries in the region (Figure 1B). For most of the period 2007-2020, Serbia has been receiving as much in FDI inflows as the other countries. Serbia’s balance of payment (Figure 1C) is indeed more deficit-driven, 3-4% below the regional level but significantly better than in 2008 (when it was -18%). Domestic savings in Serbia are lower than in the other countries but it demonstrates un upward trend, averaging at about 16% in the past 5 years (Figure 1D).
Figure 1. Regional comparisons (GFCF, FDI, BoP and savings)
(A) GFCG (B) FDI
Source: World Bank World Development Indicators
But what is the significance of the BOT for the domestic private investment? The BOT consideration is important from the perspective of savings accumulation since a negative balance implies less savings rates. But it is not of critical importance for the domestic private investment because it is limited to the share of capital goods in BOT. If the entire BOT balance is applied to the domestic investment, it would imply that it is spent on capital goods in its entirety (since there is no conception component), which is obviously not true. In fact, an analysis of Serbia’s trade structure reveals that capital goods (goods used to help increase future production) make up on average 20% of the total exports. Hence, at the level of the BOT deficit of 5-6%, capital goods are responsible for only 1%, which is a negligible amount.
What really materially affects the result in Prof. Madžar’s calculation is the appreciation rate, assumed to be 15%. This suggests an economic life of capital assets of about 6 years, which is a gross understatement. Even my dishwashing machine, to take a very down to earth example, lasted for 11 years. The service life of most of capital goods, such as roads, buildings, bridges, railroads, sewer and water systems, etc. has a service life of 30-60 years. The US Bureau of Economic Analysis (BEA 2020) suggests the following depreciation rates for different infrastructure projects (Table 1).
Table 1. BEA Depreciation Rates and Service Lives
| Category | Depreciation rate | Service life |
| Government (federal, state, and local) | ||
| Buildings | ||
| Industrial | .0285 | 32 |
| Other | .0182 | 50 |
| Non-buildings | ||
| Highways and streets | .0202 | 45 |
| Sewer systems | .0152 | 60 |
| Water systems | .0152 | 60 |
| Other | .0152 | 60 |
| Private structures | ||
| Hospitals (B) | .0188 | 48 |
| Railroad other structures | .0176 | 54 |
| Electric light and power | .0211 | 45 |
| Gas | .0237 | 40 |
| Petroleum pipelines | .0237 | 40 |
The above depreciation rates are not unique to the US but quite similar to all OECD countries varying from 2 to 6% for different infrastructure (Eurostat/OECD 2016). It is also believed that the depreciation rates are likely to increase with income assuming that the share of assets with a shorter life span (such as technology assets) rises with income levels. IMF (2015) suggests that the differential between high income and middle-income countries (to which Serbia belongs) is 1-2%. The median depreciation rate for OECD countries is 3.15%. Adjusting downward for Serbia, it should be approximately 2%. It is not clear how Prof. Madžar arrived at a depreciation rate of 15%, which he calls “conventionally and generally accepted estimates”.
What is the real rate of capital accumulation in Serbia?
With these facts established, we can now make conclusions about the net domestic investments in Serbia using the formula for GFCF: at 20% GFCF, 2% amortization rate and 1% attributable to the BOT deficit, the net domestic investment is thus about 17%. Net domestic private investment (net domestic investment minus government investment in fixed assets) is on average 13.5%, given government annual investment at 3.5%. How much is the contribution of the government and resident firms? Figure 2 (based on the National Bank of Serbia data) demonstrates this graphically. Serbia’s average GFCF during the past decade has been about 20% (17% when netted for amortization).
At the same time, FDIs accounted for 6-7% of GDP. However, GFCF does not capture the entire amount of FDI, which can be used to finance fixed capital formation but also to cover a deficit in the company or paying off a loan. Furthermore, an average of 20% of the FDI is not related to fixed capital formation and covers investments in finance, investment consultancy, administrative and other service activities. Thus, you cannot say FDI is always included in gross fixed capital formation. If the FDI is considered in the context of GFCF, its contribution should be reduced by at least 20%. All this indicates a net capital domestic accumulation of at least 14% of GDP (this is not a surprising result considering that the FDI is there to compensate for a saving gap). In other words, investments by resident entities (private and government) accounted for 70% of the total net domestic investment. Netting it further for 3.5% of government investment, leaves approximately 11% of net investments by domestic firms as a percentage of GDP, or about 60% of the entire GFCF.
It is a far cry from Prof. Madžar’s statement that “net domestic investments are zero or even negative and there is no domestic capital accumulation”. It suffices to look at the statistics provided by the Serbia Statistical Office (Figure 3) to see that new investments have been closely trailing the total investments in fixed assets, with 90% of all investments in new infrastructure, not in maintenance of the existing infrastructure.
Figure 2. Gross fixed capital formation, FDIs and saving rates (as % of GDP), 2007-2020
So, it is factually incorrect to claim, as Prof. Madžar does, that Serbia “has accepted an unusual and bizarre concept that the economy can develop permanently without its own accumulation”. But allow me to remind here that in principle there is nothing in theory that would prevent such a mechanism to operate for as long as foreign investors find it attractive to invest in a particular country.
FDI, growth and development in the world
As discussed above (Figure 1D), Serbia is not that different from the other countries in the region. Moreover, the savings rates and the marginal propensity to save differ greatly between countries, and seem to be conditioned by a multitude of social, economic and cultural factors, with little correlation with growth rates. Figure 3 demonstrates widely differing gross savings rates for a number of developing countries. The range is really impressive: from 35% in Tanzania and Bangladesh to 13% in Kenya. It also shows an interesting dynamic of divergence: four countries that started at about 15% savings rate in 2000, have greatly diverged since then as represented by Bangladesh and Kenya. The savings rates in the European Union show a similar wide range, from 7% in Greece to 28% in Germany, with Italy in between at 21% (data as of 2020). So, Serbia’s 18% is nothing exceptional.
Figure 3. Gross savings (% of GDP) in select developing countries, 2020
A number of developing economies are driven by a combination of the official development assistance and FDI at very low savings rates. There 34 countries with gross national savings rates below 10% of GDP. These are not necessarily the poorest economies and include, among others, Armenia, Bosnia, Greece, Namibia, and Ukraine. Even more interestingly, as of 2020 there are 17 countries with negative gross national savings. These include, for example, Montenegro (-2.1%) and Kosovo (-3.8%). There are numerous reasons why this is happening beyond the scope of this paper. Suffice it to say that the international policies of “comparative advantage” condemning developing countries to the role of raw material producers, don’t help much in reducing their negative balance of payment and dependence on industrial goods, which have to be imported from developed countries. The negative saving rates are typical of countries that have abandoned their monetary sovereignty and accepted other countries’ currency as their own (such as Montenegro and Kosovo which use the Euro) or rely heavily on remittances and aid (such as Lesotho and Palestine).
Our current understanding about the causes of capital accumulation and savings rates is hardly better than 65 years ago when Joan Robinson admitted: “But as to what governs the level at which it gets itself established we know very little. We know that it varies widely from period to period and from country to country, but any attempt to identify causes of variation in such influences as a tradition of vigorous competition among entrepreneurs, a rapid rate of technical progress or a high propensity to retain profits is in danger of confusing symptoms with causes.”
In other words, the answer to Prof. Madžar’s question as to whether it is possible to identify the criterion for an optimal level of FDI, is negative. The question of the effectiveness of FDI is a more complex issue. Let us go back to Prof. Madžar’s arguments against FDI: they are not effective (because investment decisions may be taken based on the incentives offered by the government rather than on the economic merits of the investment); they crowd on domestic investments (disadvantaged as a result of the same incentives); and they deter domestic savings.
The extant research is inconclusive and varies greatly for different countries, regions and periods (as Joan Robinson noted long time ago). For example, one comprehensive research (Qi 2007) that explored the causality between growth, total investment and inward FDI in 47 countries found a bidirectional causality in developing countries and a unidirectional causality from growth to investment and FDI, and from investment to FDI in developed countries. Lastly, whereas the sign of the causal effects between investment and growth/FDI is mixed in developing countries, it is consistently positive between growth and investment, and between investment and FDI in developed countries. Note also that some countries, such as Luxembourg, have large figures for FDI because they serve mainly as financial intermediaries, offering very favorable conditions such as tax exemptions for holding companies and corporate headquarters.
DOES FDI CROWD OUT OR CROWD IN DOMESTIC INVESTMENT IN CEECS
Baharumshah et al. (2002) investigated the factors that influence savings behaviour in Singapore, Malaysia, Philippines, South Korea and Thailand from 1960 to 1997. The authors found that foreign savings deter domestic savings in the short-run and long-run. In addition, causality runs from foreign savings to domestic savings. Adam, Musah and Ibrahim (2017) analyzed the causality of savings and economic growth in 10 sub-Saharan African countries and received consistent results for only three countries: Benin, Mali, and South Africa, where savings causes economic growth. For other countries, no consistent results were obtained using the same methodology. A research for the neighboring Bosnia and Herzegovina (Đidelija 2021) shows that savings and economic growth in Bosnia are cointegrated but there is no causal link between household savings and the private for-profit companies and economic growth.
Another research for the MENA (Middle East and North Africa) found that FDI crowds out domestic investment in the region (Acar et al. 2012). However, the authors attribute this effect to the peculiarities of the region, specifically privatization with no new investment created and the MNCs entry into sectors previously dominated by state-owned firms, which is quite relevant for the case of MENA. This research used GFCF as a proxy for gross domestic investment, inward FDI flows and the ratio of trade (exports plus imports) to total GDP as an indicator for the degree of integration of a country in the world economy. Unlike in other type of research that attempt to measure the impact of FDI on GDP, this approach attempts to establish the impact of FDI on domestic investment. A negative correlation between GFGC and FDI implies a crowding out effect reflecting a negative impact of foreign direct investment on gross fixed capital formation.
I used the same set of statistics for Serbia for 2010-2020 (running a distributed least squares regression estimate) and found statistically significant positive correlation between the levels of GFCF and FDI during the previous time period. To put it into perspective, one Euro of foreign investments is associated with 1.7 Euro increase in GFCF a year later, implying 0.7 Euro increase due to domestic investments – not a bad result. I’ve also added private savings into the regression equation to explore the link between GFCF and savings. The two are positively associated, albeit less significantly statistically, so that one Euro in savings is correlated with 0.67 Euro increase in GFCF the same year. This is likely to reflect that fact that private household savings are dominated by current account bank deposits and demonstrate a mismatch between short-term sources and long-term investment needs, as is generally the case in developing countries. However, a causality analysis did not establish causal links between any of the variables in the regression equation. This is not a particularly surprising finding in light of the research discussed above, which confirms that causality runs in both directions for GFCF, domestic investment and FDI.
Conclusion
Butten and Vo (2009) analyzed a panel of countries coming to a conclusion that FDI has a stronger positive impact on economic growth in countries with a higher level of education attainment, openness to international trade and stock market development, and a lower rate of population growth and lower level of risk.
This is the point of convergence between researchers. While the impact of FDI may differ significantly depending on the circumstances, the general agreement is that there is no inherent harm in FDI. It may be a sign of strength or a sign of weakness. FDI effectiveness depends on the legal and regulatory frameworks that govern such investments. Many negative impacts of FDI that their opponents emphasize are real. The latest developments around the Rio Tinto project, which the Serbian government appears to be ready to abandon due to public concerns about its environmental impact despite significant potential tax revenues and its employment impact, is an example of the potential risk as well as the government’s responsiveness. Serbia should further focus on development and, importantly, transparent enforcement, of robust laws and regulations that mitigate the potential risks of DFI, develop financial markets, and create an investment-friendly environment for both foreign and domestic investors in terms of property rights, investment security, and legal protection. The country will be rewarded with increasingly efficient overall investment as well as with more capital inflows.