The Political Economy of Foreign Direct

Investment
Chapter 7

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 The Spectrum of Political Ideology
Toward FDI

Radical Pragmatic Free

View Nationalism Market

Figure 7.1

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 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
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 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.

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 Pragmatic View
Lies somewhere between
radical and free market
views.
Gov’ts should maximize
national benefits and
minimize costs of FDI.

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 Ideology and FDI
Ideology Characteristics Host-Government Policy
Implications
Radical Marxist roots Prohibit FDI
Views the MNE as an Nationalize subsidiaries of
instrument of imperialist foreign-owned MNEs
domination

Free Classical economic roots (Smith) No restrictions on FDI

Market Views the MNE as an
instrument for allocating
production to most efficient
locations

Pragmatic Views FDI as having both Restrict FDI where costs

Nationalism benefits and costs outweigh benefits
Bargain for greater benefits
and fewer costs
Table 7.1 Aggressively court beneficial
FDI by offering incentives

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 Benefits of FDI to Host
Countries

Resource-transfer effects.
Employment effect.
Balance-of-payments effect.
Economic growth.

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 Resource-Transfer Effects
Capital.
Technology.
Management.

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 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.
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 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.
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 US Balance-of-Payments Accounts
1995
Current Account Credits Debits
$Millions Export of goods, services and $969,189
income
Merchandise 575,940
Services 210,590
Income receipts on investments 182,659
Imports of goods, services and $-1,082,268
income
Merchandise -749,364
Services -142,230
Income payments on investments -190,674
Unilateral transfers -35,075
Balance of current account -113,079
Capital Account
US assets abroad (net) -307,856
US official reserve assets -9,742
Other government assets -280
US private assets -297,834
Foreign assets in the US 424,462
Foreign official assets 109,757
Table 7.2 Other foreign assets
Balance on capital account
314,705
116,606
Statistical discrepancy 31,548

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 Economic Growth

Increased:
 productivity growth,
product and process innovation,
and greater economic growth,

Stemming from increased competition of

MNE’s investments.

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 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.
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 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.
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 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.

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 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.

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 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)

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 Cross-Border Mergers
300

250

200

150
$ Billions
100

50

0
1980
1982
1984

1990

1996
May-98
1986
1988

1992
1994

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 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.
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 The Context of Negotiation
The four Cs
Common
Conflicting
Interests Interests

Negotiation
Process

Compromise Criteria

Figure 7.2 7-19

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 Determinants of Bargaining
Power
Bargaining Power of Firm
High Low

Firms time horizon Long Short

Comparable alternatives open to Many Few

firm

Value placed by host High Low

government on investment
Table 7.3
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