The Political Economy of Foreign Direct

Investment
Chapter 7

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The Spectrum of Political Ideology

Toward FDI

Radical
View

Pragmatic
Nationalism

Free
Market
Figure 7.1

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7-1

Radical View
Marxist view is that MNEs enslave less
developed countries.
Instrument of domination
development.

not

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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7-3

Pragmatic View
Lies somewhere between
radical and free market
Govts should maximize
national benefits and
minimize costs of FDI.

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views.

7-4

Ideology and FDI

Ideology

Characteristics

Host-Government Policy
Implications

Radical

Marxistroots
ViewstheMNEasan
instrumentofimperialist
domination

ProhibitFDI
Nationalizesubsidiariesof
foreignownedMNEs

Free
Market

Classicaleconomicroots(Smith)
ViewstheMNEasan
instrumentforallocating
productiontomostefficient
locations

NorestrictionsonFDI

Pragmatic
Nationalism

ViewsFDIashavingboth
benefitsandcosts

RestrictFDIwherecosts
outweighbenefits
Bargainforgreaterbenefits
andfewercosts
Aggressivelycourtbeneficial
FDIbyofferingincentives

Table 7.1
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7-5

Benefits of FDI to Host

Countries

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

7-6
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Resource-Transfer Effects
Capital.
Technology.
Management.

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7-7

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
$Millions

Current Account
Export of goods, services and
income
Merchandise
Services
Income receipts on investments
Imports of goods, services and
income
Merchandise
Services
Income payments on investments
Unilateral transfers
Balance of current account

Credits

Debits

$969,189
575,940
210,590
182,659
$-1,082,268
-749,364
-142,230
-190,674
-35,075
-113,079

Capital Account

Table 7.2

US assets abroad (net)

US official reserve assets
Other government assets
US private assets
Foreign assets in the US
Foreign official assets
Other foreign assets
Balance on capital account
Statistical discrepancy

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-307,856
-9,742
-280
-297,834
424,462
109,757
314,705
116,606
31,548

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Economic Growth
Increased:
productivity growth,
product and process innovation,
and greater economic growth,

Stemming from increased competition of

MNEs 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 hosts
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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7-13

Home Country Problems with

FDI
Negative effect on Balance of Payments
Initial capital outflow.
MNE uses foreign subsidiary
sell back to home market.
MNE uses foreign subsidiary
a substitute for direct exports.

to
as

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

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May-98

1996

1994

1992

1990

1988

1986

1984

1982

1980

50

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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 companys approach to negotiations.
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The Context of Negotiation

The four Cs
Common

Conflicting
Interests

Interests

Negotiation
Process

Compromise

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Criteria

Figure 7.2

7-19

Determinants of Bargaining
Power
Bargaining Power of Firm
High

Low

Firms time horizon

Long

Short

Comparable alternatives open to

firm

Many

Few

Value placed by host

government on investment

High

Low

Table 7.3
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