2 The Political Economy of Foreign Direct Investment Chapter EightThe Political Economy of Foreign Direct Investment
3 Political Ideology and FDI RadicalViewPragmaticNationalismFreeMarketHistorically, 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 ViewMarxist view: MNE’s exploit less-developed host countriesExtract profitsGive nothing of value in exchangeInstrument of domination, not developmentKeep 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 communismBad economic performance of countries that embraced the radical viewStrong economic performance of countries who embraced capitalism rather than the radical view
6 The Free Market ViewNations specialize in goods and services that they can produce most efficientlyResource transfers benefit and strengthen the host countryPositive changes in laws and growth of bilateral agreements attest to strength of free market viewAll countries impose some restrictions on FDI
7 Pragmatic Nationalism FDI has benefits and costsAllow FDI if benefits outweigh costsBlock FDI that harms indigenous industryCourt FDI that is in national interestTax breaksSubsidies
9 The Benefits of FDI to Host Countries Four main benefits of FDI for a host countryResource-transfer effectEmployment effectBalance-of-Payments effectEffect on competition and economic growthIn a free market viewEconomists argue that the benefits of FDI so outweigh the costs associated with pragmatic nationalism that it is misguidedThe 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 supplyingCapitalTechnologyManagement
11 Employment Effects Brings jobs that otherwise would not be created Direct: Hiring host-country citizensIndirect:Jobs created by local suppliersJobs created by increased spending by employees of the multi-national enterpriseThe 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 sectionsThe current account records transactions that pertain to three categories: merchandise goods, services, and investment incomeThe capital account records transactions that involve the purchase or sale of assetsCurrent account deficits occur when a country imports more goods, services, and income than it exportsCurrent account surpluses occur when a country exports more goods, services, and income than it importsFDI’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 businessHost country records current account debit on repatriated earnings of MNCHost country benefits if FDI substitutes for imports of goods and servicesHost 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 pricesIncrease the economic welfare of consumersIncreased competition tends to stimulate capital investmentsLong-term results may includeIncreased productivity growthProduct and process innovationsGreater economic growth
16 Costs of FDI to Host Countries Adverse effects on competitionAdverse effects on the balance of paymentsAfter the initial capital inflow there is normally a subsequent outflow of earningsForeign subsidiaries could import a substantial number of inputsNational sovereignty and autonomySome 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 corporationThree 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 earningsCreates a demand for exports.Export demand can create jobsIncreased knowledge from operating in a foreign environmentBenefits the consumer through lower pricesFrees up employees and resources for higher value activities
18 Costs of FDI to the Home Country Can drive out local competitors or prevent their developmentProfits brought home ‘hurt’ (debit) a host’s capital accountParts imported for assembly hurt trade balanceCan affect sovereignty and national defenseInternational 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 FDIGovernment backed insurance programs to cover foreign investment riskCapital assistanceTax incentivesPolitical pressureRestricting Outward FDILimit capital outflows out of concern for the country’s balance of paymentsTax incentives to invest at homeProhibit national firms from investing in certain countries for political reasons
20 Host Country Policies and FDI Encouraging Inward FDIOffer government incentives to foreign firms to investTax concessionsLow interest loansGrants/subsidiesRestricting Inward FDIOwnership restraintsForeign firms are prohibited to operate in certain fieldsForeign ownership is allowed but a significant proportion of the equity must be owned by local investorsPerformance requirements that control the behavior of the MNE’s local subsidiary
21 The Nature of Negotiation Objective: reach an agreement that benefits both partiesIn the international context, we mustunderstand the influence of norms and value systemsbe 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 interestsConflicting interestsCompromiseCriteriaCommon 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 partiesBargaining power depends on three factorsThe value each side places on what the other has to offerThe number of comparable alternatives available to each sideEach party’s time horizon
25 Looking Ahead to Chapter 9 Regional Economic IntegrationLevels of economic integrationThe case for regional integrationThe case against regional integrationRegional economic Integration in EuropeRegional economic integration in the AmericasRegional economic integration elsewhereManagerial implications