The Political Economy of Foreign Direct Investment

Chapter 7

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The Spectrum of Political Ideology Toward FDI

RadicalView

PragmaticNationalism

FreeMarket

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Figure 7.1

Radical View Marxist view is that MNE’s enslave less

developed countries. Instrument of domination not

development.

Popular from WWII to the 1980s. Practiced by Eastern Europe, India, China, 3d

World Countries.

Ended with the collapse of Communism. Bad performance by those countries vs those

with freer market approach© McGraw Hill Companies, Inc., 2000 7-2

Free Market View

Sees FDI as way to disperse production and flow of goods and services in the most efficient manner. Supported by Smith and Ricardo and ‘market

imperfection’ explanations of FDI.

However, all countries impose some restrictions on FDI.

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Pragmatic View

Lies somewhere between radical and free market views.

Gov’ts should maximize national benefits and minimize costs of FDI.

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Ideology Characteristics Host-Government PolicyImplications

Radical Marxist rootsViews the MNE as an

instrument of imperialistdomination

Prohibit FDINationalize subsidiaries of

foreign-owned MNEs

FreeMarket

Classical economic roots (Smith)Views the MNE as an

instrument for allocatingproduction to most efficientlocations

No restrictions on FDI

PragmaticNationalism

Views FDI as having bothbenefits and costs

Restrict FDI where costsoutweigh benefits

Bargain for greater benefitsand fewer costs

Aggressively court beneficialFDI by offering incentives

Ideology and FDI

7-5© McGraw Hill Companies, Inc., 2000

Table 7.1

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Benefits of FDI to Host Countries

Resource-transfer effects. Employment effect. Balance-of-payments effect. Economic growth.

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Resource-Transfer Effects

Capital. Technology. Management.

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Employment Effects

Brings jobs that otherwise would not be created. Direct: Hiring host-country citizens. Indirect:

• Jobs created by local suppliers.

• Jobs created by increased spending by employees of the multi-national enterprise.

Questions remain on whether net jobs gained.

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Balance-of-Payments Effects

Host country benefits from initial capital inflow when MNE establishes business. Host country records current account debit on

repatriated earnings of MNE.

Host country benefits if FDI substitutes for imports of goods and services.

Host country benefits when MNE uses its foreign subsidiary to export to other countries.

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Current Account Credits DebitsExport of goods, services andincome

$969,189

Merchandise 575,940Services 210,590Income receipts on investments 182,659Imports of goods, services andincome

$-1,082,268

Merchandise -749,364Services -142,230Income payments on investments -190,674Unilateral transfers -35,075Balance of current account -113,079

Capital AccountUS assets abroad (net) -307,856US official reserve assets -9,742Other government assets -280US private assets -297,834Foreign assets in the US 424,462Foreign official assets 109,757Other foreign assets 314,705Balance on capital account 116,606Statistical discrepancy 31,548

US Balance-of-Payments Accounts 1995

$Millions

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Table 7.2

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Economic Growth

Increased: productivity growth, product and process innovation, and greater economic growth,

Stemming from increased competition of MNE’s investments.

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Host Country Problems With FDI

Drives out local competitors. Can prevent the development of ‘local’

competitors. Profits brought home ‘hurts’ (debit) a host’s

capital account. Parts imported for assembly hurt trade

balance. Can affect sovereignty and national

defense.© McGraw Hill Companies, Inc., 2000 7-12

Home Country FDI Benefits Improves balance of payments for inward flow of

foreign earnings. Creates a demand for exports.

Export demand can create jobs.

Increased knowledge from operating in a foreign environment.

Benefits the consumer through lower prices. Frees up employees and resources for higher value

activities.

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Home Country Problems with FDI

Negative effect on Balance of Payments Initial capital outflow. MNE uses foreign subsidiary to

sell back to home market. MNE uses foreign subsidiary as

a substitute for direct exports.

Potential loss of jobs.

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How Do Countries Encourage FDI?

Risk insurance.(Home) Elimination of double taxation. (Home) Tax incentives.(Host) Low interest rates. (Host) Stable government and stable policies.

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How Do Countries Discourage FDI?

Limit capital outflows. (Home) Manipulate tax code to encourage domestic

investment. (Home) Political restrictions on investing in certain

countries. (Home) Ownership restraints. (Host) Performance requirements. (Host)

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Cross-Border Mergers

0

50

100

150

200

250

30019

80

1982

1984

1986

1988

1990

1992

1994

1996

May

-98

$ Billions

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The Nature of Negotiation

Objective: reach an agreement that benefits both parties.

In the international context, must: understand the influence of

norms and value systems. Be sensitive to how these factors

influence a company’s approach to negotiations.

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The Context of NegotiationThe four Cs

Common

Interests

Compromise

Negotiation

Process

Conflicting Interests

Criteria

7-19Figure 7.2

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Determinants of Bargaining Power

Bargaining Power of FirmHigh Low

Firms time horizon

Comparable alternatives open to firm

Value placed by host government on investment

Long Short

Low

Many Few

High

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Table 7.3