Are Foreign Firms Privileged By Their Host Governments? EvidAre Foreign Firms Privileged by their Host Governments? EvidAre foreign firms privileged?National preference hypothesisSome tentative hypothesesData and variablesWorld Business Environment Survey (WBES)Variable descriptionsDependent variableVariables of interestControl variablesThe FindingsBaseline modelsExploring mechanisms of foreign privilegeConcluding remarksAppendix: Prior research in regional studies on foreign privTablesBibliographyMIT Sloan School of ManagementWorking Paper 4538-04March 2005Are Foreign Firms Privileged By Their Host Governments?Evidence From The 2000 World Business Environment SurveyYasheng Huang© 2005 by Yasheng Huang.All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted withoutexplicit permission, provided that full credit including © notice is given to the source.This paper also can be downloaded without charge from theSocial Science Research Network Electronic Paper Collection:http://ssrn.com/abstract=721221Are Foreign Firms Privileged By Their Host Governments? Evidence From The 2000 World Business Environment Survey Yasheng Huang Sloan School of Management MIT 50 Memorial Drive, E52-562 Cambridge, MA 02142 [email protected] This version: March 2005 This draft is very preliminary and incomplete. Please do not quote or circulate without permission. Comments are welcome. Abstract Using the data from World Business Environment Survey (WBES) on over 10,000 firms across eighty one countries, this paper finds preliminary evidence that foreign firms enjoy significant regulatory advantages—as perceived by the firms themselves—over domestic firms. The findings on regulatory advantages of foreign firms hold with a variety of alternative measures of regulations and with or without firm- and country-level attributes and industry and country controls. There is also evidence that foreign firms’ regulatory advantages are especially substantial vis-à-vis the politically weak domestic firms. Furthermore, the regulatory advantages of foreign firms appear stronger in corrupt countries than in non-corrupt countries. 1Are Foreign Firms Privileged by their Host Governments? Evidence from the 2000 World Business Environment Survey In his seminal book, The Other Path: The Invisible Revolution in the Third World, Hernando de Soto documented the extremely difficult regulatory environment facing small businesses in Peru. In a real social science experiment, de Soto assembled a research team and instructed the team to follow all the required bureaucratic procedures in setting up a one-employee garment factory. The process took the team members 289 days and cost them $1,231 altogether, an equivalent of three years in average Peruvian wage (De Soto 1989). De Soto’s social science experiment was conducted in 1983 and we should note the broad policy context of his accounts of the business on the ground at the time. The early 1980s in Peru, in fact, coincided with a move away from the state-led development strategy Peru adopted since 1968. As a number of Latin American specialists noted, the administration of Fernando Belaunde (1980-1985) undertook a privatization program, promoted primary exports and, above all, aggressively pursued foreign direct investment (FDI) by conferring substantial tax and other benefits on foreign firms (Pastor and Wise 1992; Wise 1994). This paper will show that this juxtaposition of regulatory constraints imposed on domestic firms on the one hand with an active FDI promotion stance on the other is by no means limited to Peru in the 1980s. The other dynamic de Soto noted in his book also runs through this paper. The kind of regulatory constraints documented in The Other Path did not fall on all domestic firms in Peru but fell disproportionately on the small and politically powerless domestic firms. In fact, the cumbersome regulatory procedures and requirements benefited the small group of political and economic elites, who could circumvent these constraints easily with their political power and connections. One could argue further, as (Shleifer 1993 ) did, that these complicated regulations were instituted so that bureaucrats could solicit bribes. This paper looks at the effect on the regulatory environment facing foreign firms in the presence of a political bifurcation of domestic firms and in the presence of corruption. In the FDI research, there is a long and venerable view that host governments discriminate against foreign firms in order to protect domestic firms.1 This is known as the “national preference” view of the world.2 Despite the prominence of the national preference claim, few have actually examined this claim 1 We focus on governments in their host capacities. Foreign firms here refer to the resident subsidiaries or affiliates established via FDI and by firms located outside the host countries. By this definition, purely importing foreign firms are excluded; so are financial foreign firms that have invested in stocks overseas. 2 The phrase, “national preference,” belongs to (Caves 1996). 2empirically. In this paper, we first identify a number of empirical and conceptual shortcomings with the national preference claim and then we will provide evidence to support an opposite claim—that host governments often privilege foreign firms at the expense of domestic firms, especially politically-weak domestic firms. We call the alternative to the national preference claim “foreign privilege” claim in this paper. As far as this author is aware, this is the first paper that examines the national preference claim empirically on the basis of cross-country evidence. 3 A number of detailed regional studies—of Latin America, China and Malaysia—have uncovered and offered valuable insights about the foreign privilege phenomenon (summarized in the appendix to this paper), but these insights have not been generalized to other countries. 4 The data used in this paper come from World Business Environment Surveys (WBES), implemented between 1999 and 2000 in eighty-one countries and on more than 10,000 firms operating in these countries. Based on an analysis of the survey data, this paper makes—and provides evidence for—three claims. First, there is strong and consistent evidence that there are substantial regulatory advantages to being a foreign firm operating in these eighty-one economies as compared with an average
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