1. © Ram Mudambi, Temple University, 2005 1 The Political Economy of Foreign Direct Investment Ram Mudambi IMBA BA 951 Spring 2005

2. © Ram Mudambi, Temple University, 2005 2 Why is FDI growing more rapidly than world trade or output? World political and economic change Improved logistics Wider acceptance of MNC operations Movement of operations to the most efficient location Most international trade is intra-firm MACRO

3. © Ram Mudambi, Temple University, 2005 3 Why is FDI growing more rapidly than world trade or output? Growing power of regional economic blocs EU, NAFTA, Mercosur, etc. Strategy of extra-bloc firms to become ‘domestic’ ‘Tariff-jumping’ FDI MICRO

4. © Ram Mudambi, Temple University, 2005 4 The Spectrum of Political Ideology Toward FDI Radical View Pragmatic Nationalism Free Market

5. © Ram Mudambi, Temple University, 2005 5 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, 3rd World Countries.  Ended with the collapse of Communism.  Bad performance by those countries vs those with freer market approach

6. © Ram Mudambi, Temple University, 2005 6 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.

7. © Ram Mudambi, Temple University, 2005 7 Pragmatic View  Lies somewhere between radical and free market views.  Governments should maximize national benefits and minimize costs of FDI.

8. © Ram Mudambi, Temple University, 2005 8 Ideology and FDI IdeologyCharacteristics Host-Government Policy Implications Radical  Marxist roots  Views FDI as an imperialist tool  Prohibit FDI  Nationalize MNC subsidiaries Free Market  Classical economic roots  FDI as a tool for efficient location of operations  No restrictions on FDI Pragmatic Nationalism  FDI has both benefits and costs  Court targeted MNCs  Tailor incentives

9. © Ram Mudambi, Temple University, 2005 9 What do the data tell us? – 1  MNC economic interests are overwhelmingly concentrated in the triad – North America, Europe and Japan/East Asia  There is no evidence that triad governments are subject to ‘control’ by MNCs  Competitive pressures cause MNCs to cancel each other out  Activities outside the triad are too insignificant to justify expense of political activities  E.g., a recent CIMA study found that most MNCs followed ‘whiter than white’ accounting practices

10. © Ram Mudambi, Temple University, 2005 10 What do the data tell us? – 2  Globalization refers to FDI, not financial flows  FDI flows are extremely stable  MNC strategies tend to be regional, rather than global, reflecting regional trading blocs  Fears of global homogenization are over-rated  EU, NAFTA, Mercosur, APEC  MNCs tend to be “flagship firms” – serve as hubs of extensive business networks/clusters

11. © Ram Mudambi, Temple University, 2005 11 Benefits of FDI to Host Countries  Resource-transfer effects  Capital, technology, management  Employment effects  Balance-of-payments effects  Economic growth

12. © Ram Mudambi, Temple University, 2005 12 FDI and resource-transfer effects HOME Parent HOST Subsidiary Spillover of technology and management practices Inflow of capital

13. © Ram Mudambi, Temple University, 2005 13 FDI and employment effects HOST Subsidiary Direct local jobs created Jobs created in local supplier & ancillary network Jobs created due to increased income generation Jobs lost in local firms that are driven out of business

14. © Ram Mudambi, Temple University, 2005 14 FDI and balance of payments HOME Parent HOST Subsidiary Local output replaces imports (+) Inflow of capital (+) Repatriated profits (-) 3 rd Country Subsidiary exports (+) Taxes, tariffs and other payments to the govt. (+)

15. © Ram Mudambi, Temple University, 2005 15 Economic Growth  Increased:  productivity growth,  product and process innovation,  and greater economic growth, Stemming from increased competition of MNE’s investments.

16. © Ram Mudambi, Temple University, 2005 16 How Do Countries Encourage FDI?*  Risk insurance.(Home)  Elimination of double taxation. (Home)  Tax incentives.(Host)  Low interest rates. (Host)  Grants for land and training of workforce (Host)  Stable government and stable policies (Host) *See http://sbm.temple.edu/~rmudambi/Publications/Mudambi%20IJEB.pdfhttp://sbm.temple.edu/~rmudambi/Publications/Mudambi%20IJEB.pdf

17. © Ram Mudambi, Temple University, 2005 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)

18. © Ram Mudambi, Temple University, 2005 18 Determinants of Bargaining Power Bargaining Power of Firm HighLow Firms time horizon LongShort Comparable alternatives open to firm ManyFew Value placed by host government on investment LowHigh