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The Political Economy of Foreign Direct Investment

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2 The Political Economy of Foreign Direct Investment
Chapter Eight The Political Economy of Foreign Direct Investment

3 Political Ideology and FDI
Radical View Pragmatic Nationalism Free Market Historically, ideology toward FDI has ranged from a dogmatic radical stance that is hostile to all FDI at one extreme to an adherence to the noninterventionist principle of free market economics at the other. Between these two extremes is an approach that might be called pragmatic nationalism.

4 The Radical View Marxist view: MNE’s exploit less-developed host countries Extract profits Give nothing of value in exchange Instrument of domination, not development Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology

5 The Radical View By the end of the 1980s radical view was in retreat
Collapse of communism Bad economic performance of countries that embraced the radical view Strong economic performance of countries who embraced capitalism rather than the radical view

6 The Free Market View Nations specialize in goods and services that they can produce most efficiently Resource transfers benefit and strengthen the host country Positive changes in laws and growth of bilateral agreements attest to strength of free market view All countries impose some restrictions on FDI

7 Pragmatic Nationalism
FDI has benefits and costs Allow FDI if benefits outweigh costs Block FDI that harms indigenous industry Court FDI that is in national interest Tax breaks Subsidies

8 Summary of Political Ideology
Table 8.1, p. 268

9 The Benefits of FDI to Host Countries
Four main benefits of FDI for a host country Resource-transfer effect Employment effect Balance-of-Payments effect Effect on competition and economic growth In a free market view Economists argue that the benefits of FDI so outweigh the costs associated with pragmatic nationalism that it is misguided The best policy would be for countries to forgo all intervention in an MNE’s investment decisions

10 Resource-Transfer Effects
FDI can make a positive contribution to a host economy by supplying Capital Technology Management

11 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 The effects of FDI on employment are both direct and indirect. Direct effects arise when a foreign MNE employs a number of host-country citizens. Indirect effects arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE. The indirect employment effects are often as large as, if not larger than, the direct effects. The question always remains about the true number of net jobs created or lost however.

12 Balance-of-Payments Effects
Balance-of-Payments Accounts are divided into two main sections The current account records transactions that pertain to three categories: merchandise goods, services, and investment income The capital account records transactions that involve the purchase or sale of assets Current account deficits occur when a country imports more goods, services, and income than it exports Current account surpluses occur when a country exports more goods, services, and income than it imports FDI’s effect on a country’s balance-of-payments accounts is an important policy issue for most host governments. To understand this concern, we must first familiarize ourselves with balance-of-payments accounting. Then we will examine the link between FDI and the balance-of-payments accounts. Governments normally are concerned when the country is running a deficit on the current account of the balance of payments. When a country runs a current account deficit, the money that flows to other countries is then used by those countries to purchase assets in the deficit country. Thus, when the United States runs a trade deficit with Japan, the Japanese use the money that they receive from U.S. consumers to purchase U.S. assets such as stocks, bonds, and the like. Put another way, a deficit on the current account is financed by selling assets to other countries; that is, by a surplus on the capital account. Thus, the U.S. current account deficit during the 1980s, 1990s, and early 2000s was financed by a steady sale of U.S. assets (stocks, bonds, real estate, and whole corporations) to other countries. Countries that run current account deficits become net debtors.

13 US Balance of Payment Accounts for 2004
A basic principle of balance-of-payments accounting is double-entry bookkeeping. Every international transaction automatically enters the balance of payments twice— once as a credit and once as a debit. Imagine that you purchase a car produced in Japan by Toyota for $20,000. Since your purchase represents a payment to another country for goods, it will enter the balance of payments as a debit on the current account. Toyota now has the $20,000 and must do something with it. If Toyota deposits the money at a U.S. bank, the transaction will show up as a $20,000 credit on the capital account. Or Toyota might deposit the cash in a Japanese bank in return for Japanese yen. Now the Japanese bank must decide what to do with the $20,000. Any action that it takes will ultimately result in a credit for the U.S. balance of payments. For example, if the bank lends the $20,000 to a Japanese firm that uses it to import personal computers from the United States, then the $20,000 must be credited to the U.S. balance-of-payments current account. Or the Japanese bank might use the $20,000 to purchase U.S. government bonds, in which case it will show up as a credit on the U.S. balance-of-payments capital account. Table 8.2, p. 272

14 Balance-of-Payments Effects
Host country benefits from initial capital inflow when MNC establishes business Host country records current account debit on repatriated earnings of MNC Host country benefits if FDI substitutes for imports of goods and services Host country benefits when MNC uses its foreign subsidiary to export to other countries

15 Effect on Competition and Economic Growth
Greenfield investments increases the amount of competition, which can: Drive down prices Increase the economic welfare of consumers Increased competition tends to stimulate capital investments Long-term results may include Increased productivity growth Product and process innovations Greater economic growth

16 Costs of FDI to Host Countries
Adverse effects on competition Adverse effects on the balance of payments After the initial capital inflow there is normally a subsequent outflow of earnings Foreign subsidiaries could import a substantial number of inputs National sovereignty and autonomy Some host governments worry that FDI is accompanied by some loss of economic independence resulting in the host country’s economy being controlled by a foreign corporation Three primary costs of FDI concern to host countries are: adverse effects on competition, adverse effects on the balance of payments; and a loss of national sovereignty and autonomy.

17 Benefits of FDI to the Home Country
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

18 Costs of FDI to the Home Country
Can drive out local competitors or prevent their development Profits brought home ‘hurt’ (debit) a host’s capital account Parts imported for assembly hurt trade balance Can affect sovereignty and national defense International trade theory tells us that home-country concerns about the negative economic effects of offshore production may be misplaced. The term offshore production refers to FDI undertaken to serve the home market. Far from reducing home-country employment, such FDI may actually stimulate economic growth (and hence employment) in the home country by freeing home-country resources to concentrate on activities where the home country has a comparative advantage. In addition, home-country consumers benefit if the price of the particular product falls as a result of the FDI. Also, if a company were prohibited from making such investments on the grounds of negative employment effects while its international competitors reaped the benefits of low-cost production locations, it would undoubtedly lose market share to its international competitors. Under such a scenario, the adverse long-run economic effects for a country would probably outweigh the relatively minor balance-of-payments and employment effects associated with offshore production.

19 Home Country Policies and FDI
To encourage outward FDI Government backed insurance programs to cover foreign investment risk Capital assistance Tax incentives Political pressure Restricting Outward FDI Limit capital outflows out of concern for the country’s balance of payments Tax incentives to invest at home Prohibit national firms from investing in certain countries for political reasons

20 Host Country Policies and FDI
Encouraging Inward FDI Offer government incentives to foreign firms to invest Tax concessions Low interest loans Grants/subsidies Restricting Inward FDI Ownership restraints Foreign firms are prohibited to operate in certain fields Foreign ownership is allowed but a significant proportion of the equity must be owned by local investors Performance requirements that control the behavior of the MNE’s local subsidiary

21 The Nature of Negotiation
Objective: reach an agreement that benefits both parties In the international context, we must understand the influence of norms and value systems be sensitive to how these factors influence a company’s approach to negotiations

22 The Negotiation Process
The negotiation process has been characterized as occurring within the context of “the four Cs” Common interests Conflicting interests Compromise Criteria Common interests are the goals that the MNE and the country have in common. Conflicting interests arise from such issues as the proportion of component parts that will be procured locally rather than imported, the total amount of investment, the total number of jobs created, and the proportion of output that will be exported. Compromise involves reaching a decision that brings benefits to both parties, even though neither will get all of what it wants. MNE’s criteria or objectives are to achieve satisfactory profits and to maintain 100 percent ownership. The country’s criteria are to achieve satisfactory net benefits from the resource-transfer, employment, and balance-of-payments effects of the investment. Figure 8.1, p. 283

23 Negotiation and Bargaining Power
The outcome of any negotiated agreement depends on the relative bargaining power of both parties Bargaining power depends on three factors The value each side places on what the other has to offer The number of comparable alternatives available to each side Each party’s time horizon

24 Bargaining Power Table 8.3, p. 284

25 Looking Ahead to Chapter 9
Regional Economic Integration Levels of economic integration The case for regional integration The case against regional integration Regional economic Integration in Europe Regional economic integration in the Americas Regional economic integration elsewhere Managerial implications

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