2 The Political Economy of Foreign Direct Investment CHAPTER 7The Political Economy of Foreign Direct Investment
3 Chapter Focus This chapter examines the role of government in FDI. Through its actions, governments can encourage or discourage FDI by providing investment incentives or passing laws/implementing policies that restrict foreign investment.Political ideology influences government policy.
4 Political Ideology and FDI RadicalViewFreeMarketPragmaticNationalism
5 Radical View Marxist roots. Influential from 1945 to the 80s. Failure. An instrument of imperialist domination.Exploit host country for the benefit of the MNE.Keeps less developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology.Influential from 1945 to the 80s.Eastern Europe, China, Cuba, some African countries, Iran, and India.Failure.Collapse of Communism.Poor economic performance.Strong economic performance of countries embracing capitalism.
6 Free Market View Roots in Smith and Ricardo. International production should be distributed among countries according to the theory of competitive advantage.Positive changes in laws and growth of bilateral agreements attest to strength of free market view.However, all governments, to some degree, intervene in the free market.
7 Pragmatic Nationalism View FDI as having both benefits and costs.Governments tend toward FDI when benefits versus costs are high.Aggressively court FDI that has national interest ramifications, typically through tax breaks or grants.Technology.Employment.Balance of payment benefits.
8 Political Ideology Toward FDI CharacteristicsHost-Government PolicyImplicationsRadicalFreeMarketPragmaticNationalismMarxist rootsViews the MNE as aninstrument of imperialistdominationProhibit FDINationalize subsidiaries offoreign-owned MNEsClassical economic roots (Smith)Views the MNE as aninstrument for allocatingproduction to most efficientlocationsNo restrictions on FDIViews FDI as having bothbenefits and costsRestrict FDI where costsoutweigh benefitsBargain for greater benefitsand fewer costsAggressively court beneficialFDI by offering incentivesTable 7.1
9 Benefits of FDI to Host Countries Resource-TransferEffectsManagementCapitalTechnologyEmploymentDirectIndirectBalance-of-Payments
10 US Balance-of-Payments Accounts 2000 $MillionsTable 7.2
11 FDI and Balance-of-Payments Current Account Deficit occurs when imports are greater than exports.Current Account Surplus occurs when exports are greater than imports.Capital Account records transactions that involve the purchase or sale of assets.3 B-of-P Consequences:When MNE establishes its foreign subsidiary, the host country benefits from initial capital inflow.If the FDI is a substitute for imports, it improves the host country’s balance of payments.Subsidiary is used for exports.
12 Effect on Competition and Economic Growth FDI can:Increase market competition.Lower prices.Greater consumer choice.Stimulate capital investments.Increase:Productivity.Product/process innovation.Economic growth.
13 Costs of FDI to Host Countries Adverse EffectsonCompetitionon theBalance ofPaymentsSovereigntyandAutonomyDrive outlocalcompetitorsEarnings &imports hurtcapitalaccountKey economicdecisions madeby ‘foreigners’
14 Benefits and Costs of FDI to Home Countries Inwardflow ofearningsCreatesexportdemandIncreasedknowledgeBalanceofPaymentshurtPotentialreductionin homecountryemploymentInitialcapitaloutflowSellsback tohomemarketSubstituteforexports
15 International Trade Theory and FDI Home-country concerns about offshore production may be misplaced.Offshore production refers to FDI undertaken to serve the home market.May increase employment by freeing home country resources to concentrate on activities where the home country has a competitive advantage.May lead to lower prices for consumers.
16 Government Policy Instruments and FDI Home Country PoliciesEncourage Outward FDIGovernment backed risk insurance.Government loans.Eliminate double taxation.Political persuasion to relax restrictions on inbound FDI.Restricting Outward FDILimit capital outflows.Use tax code to encourage companies to stay home.Prohibitions against investing in certain countries (Cuba, Libya, Iran).
17 Government Policy Instruments and FDI Host Country PoliciesEncourage Inward FDIOffer investment incentives.Tax concessions.Low-interest loans.Grant/subsidies.Attempt to attract investment away from other countries.Restricting Inward FDIOwnership restraints.Excluded from specific fields.National security.Competition.Restrictions on amount of ownership.Performance requirements.Local content.Technology transfer.Local participation in management
18 International Institutions and the Liberalization of FDI WTOOECDDeveloped nationshave had problemsagreeing on rules.Developing nationshave been reluctantto agree toliberalization.
19 The Context of Negotiation The four Cs CommonInterestsNegotiationProcessConflicting InterestsCriteriaCompromiseCompromiseFigure 7.1
20 Determinants of Bargaining Power Bargaining Power of FirmHighLowLongShortLowManyFewHighFirms time horizonComparable alternatives open to firmValue placed by host government on investmentTable 7.3