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Fourth Edition International Business
CHAPTER 7 The Political Economy of Foreign Direct Investment
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-3 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-4 Political Ideology and FDI Radical View Free Market Pragmatic Nationalism
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-5 Radical View Marxist roots. 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-6 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-7 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-8 Political Ideology Toward FDI IdeologyCharacteristicsHost-Government Policy Implications Radical Free Market Pragmatic Nationalism Marxist roots Views the MNE as an instrument of imperialist domination Prohibit FDI Nationalize subsidiaries of foreign-owned MNEs Classical economic roots (Smith) Views the MNE as an instrument for allocating production to most efficient locations No restrictions on FDI Views FDI as having both benefits and costs Restrict FDI where costs outweigh benefits Bargain for greater benefits and fewer costs Aggressively court beneficial FDI by offering incentives Table 7.1
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. 7-9 Benefits of FDI to Host Countries Resource-Transfer Effects Management Capital Technology Employment Effects Direct Indirect Balance-of-Payments Effects
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved US Balance-of-Payments Accounts 2000 $Millions Table 7.2
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Costs of FDI to Host Countries Adverse Effects on Competition Adverse Effects on the Balance of Payments Adverse Effects on Sovereignty and Autonomy Drive out local competitors Earnings & imports hurt capital account Key economic decisions made by ‘foreigners’
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Benefits and Costs of FDI to Home Countries Inward flow of earnings Creates export demand Increased knowledge Balance of Payments hurt Potential reduction in home country employment Initial capital outflow Sells back to home market Substitute for exports
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved 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.
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Government Policy Instruments and FDI Encourage Outward FDI Government backed risk insurance. Government loans. Eliminate double taxation. Political persuasion to relax restrictions on inbound FDI. Restricting Outward FDI Limit capital outflows. Use tax code to encourage companies to stay home. Prohibitions against investing in certain countries (Cuba, Libya, Iran). Home Country Policies
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Government Policy Instruments and FDI Encourage Inward FDI Offer investment incentives. Tax concessions. Low-interest loans. Grant/subsidies. Attempt to attract investment away from other countries. Restricting Inward FDI Ownership restraints. Excluded from specific fields. National security. Competition. Restrictions on amount of ownership. Performance requirements. Local content. Technology transfer. Local participation in management Host Country Policies
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Developed nations have had problems agreeing on rules. Developing nations have been reluctant to agree to liberalization. International Institutions and the Liberalization of FDI WTOOECD
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved The Context of Negotiation The four Cs Compromise Figure 7.1 Common Interests Negotiation Process Conflicting Interests Criteria Compromise
McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved Determinants of Bargaining Power Bargaining Power of Firm HighLow Firms time horizon Comparable alternatives open to firm Value placed by host government on investment LongShort Low ManyFew High Table 7.3
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