Preliminary Draft: not for Quote THE OFFICIAL DEVELOPMENT ASSISTANCE AS A CATALYST OF FOREIGN DIRECT INVESTMENT AND INDUSTRIAL AGGLOMERATION Matsuo WATANABE Japan Institute of International Affairs 1. INTRODUCTION This chapter is intended to investigate the contribution of infrastructure development financed by official development assistance (ODA) to attracting foreign direct investment (FDI) and formation of industrial agglomeration with reference to the automotive industry in Thailand. Thailand has been one of the major production bases in the ASEAN, and currently there are 700 automotive-related companies. The origin of the industry in Thailand dates back to the 1960s when the country invited foreign manufacturers, mainly Japanese, under the import substitution industrialisation (ISI) strategy. The country subsequently changed to an export-oriented strategy in the beginning of the 1970s afterwards which has led to the remarkable success of industrialisation (including automotive sector) and economic development. The success of Thai automotive industry is represented by the expansion of volume of production and export which has been the largest among ASEAN members. This expansion is enabled by a concentration of investments in the industry (known as ‘agglomeration’), among others, from foreign part suppliers in the Eastern Seaboard (ESB) area. The determinants of FDI have been analysed in number of past literature including FDI to the ASEAN economies in which provision of infrastructure as well as existence of industrial agglomeration have positive impacts on attracting FDI1. 1 For example, Kohama and Urata (2001) stress the importance of host countries’ condition in 1 This study investigates how the agglomeration of automotive industry has taken place in Thailand. In particular, special attention is placed on the shift of concentration of new investments over the last two decades in accordance with the development of infrastructure in the ESB and Bangkok Metropolitan area - of which large part was financed by Japan’s ODA in the same period. This chapter is organised as follows. Section 2 reviews the Thai government’s past economic policy and the path to industrialisation. Section 3 overviews the development of the ESB area with particular reference to the establishment of various infrastructure. Subsequently, after the situation of Thai automotive industry is outlined in Section 4, the formation of automotive agglomeration is analysed, followed by the discussion of Thailand’s attractiveness to investors. And section 5 concludes this chapter2. 2. THAILAND’S ECONOMIC POLICY AND THE PATH TO INDUSTRIALISATION Thailand has achieved remarkable industrialisation in the last two decades largely led by FDI from Japan and other countries. In particular the country has seen industrial agglomeration of automotive and electricity which accounts for the successful industrialisation as mentioned in the previous section. The following sections examine the case of automotive agglomeration in the ESB area and Japanese companies’ investment behaviour which has transformed in accordance with infrastructural development in the ESB financed by Japanese ODA. Firstly, Thailand’s chronological industrial policy infrastructural development plan for the ESB is reviewed. determination of FDI location by Japanese companies. For FDI in transportation equipment to developing countries, provision of electricity and other infrastructure, industrial agglomeration and capacity of governance have been designated as major factors to attract FDI (with statistical significance). Tejima (1998) argues that a significant shit of Japanese companies’ motivation of FDI has been observed in 1993-94 period afterwards. Traditional motivations to invest foreign countries are i) market seeking, ii) efficiency of production and costs and iii) securing natural resources. In fact Japanese investments in the 1980s onwards have been motivated by the three reasons. The mid-1990s saw two emerging motivations: a) to establish exporting base for third countries and b) to supply parts to existing assembling factories. Interestingly, the two appear to be important determinants of investment when Japanese FDI to Asia started to resurge. In particular, the second determinant ‘b’ is observed in automotive and electric/electronics industries in which close network between assembling manufacturers and part suppliers is essential to maintain competitiveness. 2 This study centres on the formation of agglomeration and does not explicitly evaluate the impacts of the agglomeration to Thai economy. 2 Subsequently agglomeration of automotive industry in the ESB is investigated by looking at trajectory of the industry in Thailand and the process of agglomeration in the ESB, followed by the factors which enabled the agglomeration including Japan’s ODA. Thailand’s industrialisation dates back to the 1960s when the country introduced ISI strategy followed by an export-oriented strategy in the 1970s which, then, has been expanded by foreign capital inflows afterwards (Development Bank of Japan 2001). The Thai government embarked on industrialisation in the end of the 1950s by which the main source of income was agriculture, e.g. rice. In 1961 an economic development plan was introduced to establish industrial base through encouraging foreign investment3. The ISI strategy, however, collapsed due to an increasing trade deficit caused by the import of capital goods. The government then altered strategy to promoting export-oriented industries by offering various incentives such as a reducing customs on imports necessary for producing exporting goods and preferential financing for exporters. Through these incentives, labour intensive industries, e.g. food processing and textile, saw a notable growth. The NEDB and its successor the NESDB have played significant role in Thai industrialisation. The agencies report to the prime minister and have written nine National Economic Plans (NEP) since 1961 (Table 2). The first and second NEP (1961-66 and 1966-71, respectively) typically followed ISI strategy, imposing high tariffs on imports to protect domestic industries while developing infrastructure by public investment. During the NEP II attention was directed to mobilising domestic resources and promoting labour intensive industries, textile in particular. The domestic industries, however, lost price competitiveness due to the failure of ISI including a rise in domestic prices, decrease in foreign reserve, declining exports caused by appreciation of the currency and constraints of small domestic markets. As such stagnating exports and increasing imports ended up with deteriorating balance of payment in the end of the 1960s. The NEP III (1971-76) saw a drastic change in which an export-oriented industrialisation was introduced. In 1972 Industrial Investment Promotion Act was 3 Thailand’s automotive industry initiated this period through ISI driven investment by Japanese assemblers. 3 replaced by Investment Promotion Act which was intended to promote export industries, to disperse industrial areas over the country and to invite foreign capitals selectively. Export-oriented industrialisation policy aimed at mobilising domestic raw materials and labour to export industries. In addition, the government introduced various incentive schemes including tariff reduction on inputs for export goods and offering low rate loans to exporters4. The export-oriented policy remained throughout the NEP IV and V (1976-81 and 1981-86, respectively) with the government’s promotion of export industries, establishment of export processing zones and support for large scale exporters. The government also explored natural gas and developed petrochemical and chemical fertiliser industries which contributed to the country’s rapid industrialisation. Exports of industrial products increased from 25 percent of total exports in 1970 to 35 percent in 1980 when industrial exports first exceeded agricultural ones. Table 4 shows that Thailand’s manufacturing value added (MVA) grew remarkably compared to developing countries - MVA and per capita MVA grew at 10.5 and 7.5 percent respectively during the 1970s while developing countries saw 6.8 and 4.5 percent growth in the same period. The decade from mid 1980s saw increasing FDI inflows from Japan (largely reflecting the rapid appreciation of Yen), Hong Kong, Singapore and Taiwan and high economic growth. FDI flows were directed to technology-oriented industries, e.g. electric/electronic and integrated circuit (IC)–related ones, which led Thailand’s industrialisation along with textile and metal goods. The NEP VI (1986-91) promoted investment from private sector and privatisation of energy sector in particular, while the subsequent NEP VII (1991-96) encouraged investment to divert to regions out of Bangkok such as Chenmai, with particular interests in food processing, textile, metal, electric/electronic, petrochemical and steel industries. As seen in Table 3, the country appeared to succeed to enhance manufacturing sector from 21.5 percent of GDP in 1980 to about 30 percent in the mid 1990s, while the share of agriculture, forestry and fishery sector altogether more than halved from 23.2 percent to less than 10 percent in the same period. MVA per capita in 1990 (US$418) was twice as much as developing countries 4 The reduction, however, did not work significantly as incentives since customs revenue accounted for a major part of government revenue (Development Bank of Japan 2001). 4 (US$203)