1. The Political Economy of Foreign Direct Investment Chapter 7 © McGraw Hill Companies, Inc., 2000

2. The Spectrum of Political Ideology Toward FDI Radical View Pragmatic Nationalism Free Market © McGraw Hill Companies, Inc., 2000 7-1 Figure 7.1

3. 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

4. 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. © McGraw Hill Companies, Inc., 2000 7-3

5. Pragmatic View  Lies somewhere between radical and free market views.  Gov’ts should maximize national benefits and minimize costs of FDI. © McGraw Hill Companies, Inc., 2000 7-4

6. IdeologyCharacteristicsHost-Government Policy Implications Radical Marxist roots Views the MNE as an instrument of imperialist domination Prohibit FDI Nationalize subsidiaries of foreign-owned MNEs Free Market Classical economic roots (Smith) Views the MNE as an instrument for allocating production to most efficient locations No restrictions on FDI Pragmatic Nationalism 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 Ideology and FDI 7-5 © McGraw Hill Companies, Inc., 2000 Table 7.1

7. © McGraw Hill Companies, Inc., 2000 Benefits of FDI to Host Countries  Resource-transfer effects.  Employment effect.  Balance-of-payments effect.  Economic growth. 7-6

8. © McGraw Hill Companies, Inc., 2000 Resource-Transfer Effects  Capital.  Technology.  Management. 7-7

9. © McGraw Hill Companies, Inc., 2000 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. 7-8

10. © McGraw Hill Companies, Inc., 2000 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. 7-9

11. © McGraw Hill Companies, Inc., 2000 US Balance-of-Payments Accounts 1995 $Millions 7-10 Table 7.2

12. © McGraw Hill Companies, Inc., 2000 Economic Growth  Increased:  productivity growth,  product and process innovation,  and greater economic growth, Stemming from increased competition of MNE’s investments. 7-11

13. 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

14. 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. © McGraw Hill Companies, Inc., 2000 7-13

15. © McGraw Hill Companies, Inc., 2000 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. 7-14

16. 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. 7-15 © McGraw Hill Companies, Inc., 2000

17. 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) 7-16

18. Cross-Border Mergers © McGraw Hill Companies, Inc., 2000 7-17

19. © McGraw Hill Companies, Inc., 2000 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. 7-18

20. © McGraw Hill Companies, Inc., 2000 The Context of Negotiation The four Cs Common Interests Compromise Negotiation Process Conflicting Interests Criteria 7-19 Figure 7.2

21. © McGraw Hill Companies, Inc., 2000 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 7-20 Table 7.3