Chapter
7
The Political
Economy Of Foreign
Direct Investment
7-2
Case: FDI and the Irish miracle



FDI in Ireland grew from $164m (1985) to
$24b (2000)
By 2000 two-thirds of Irelands top
exporters were MNEs
Reasons for Ireland’s success



Member of EU (access to EU markets)
Highly educated workforce
Good infrastructure
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-3
Political ideology and FDI
Radical
View
McGraw-Hill/Irwin
International Business, 5/e
Pragmatic
Nationalism
Free
Market
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-4
Radical view

Marxist view, that 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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-5
Radical view

Radical view was popular (1945-80) among



Communist countries (China, Cuba)
Socialist countries in Africa
Nationalistic countries (Iran, India)
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-6
Radical view-short lived?

By end 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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-7
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
However, all countries impose some
restrictions on FDI
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-8
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-9
Three main ideological positions
regarding FDI
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-10
Benefits of FDI to host countries

Resource-transfer effects




Capital
Technology
Management
Employment effect


Direct
indirect
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-11
Benefits of FDI to host countries


Balance-of-payments effect.
 Current account-surplus/deficit
 Capital account
Increases competition and spurs economic
growth
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-12
Resource-transfer effects

Capital

Technology

Management
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-13
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-14
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-15
Balance of payment accounts



Current account deficit occurs when imports
are greater than exports
Current account surplus occurs when exports
are greater than imports
Capital account records transactions that
involve the purchase or sale of assets
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-16
U.S. Balance of payments accounts
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-17
Effect on competition and economic
growth

Increased




productivity growth
product and process innovation
greater economic growth
FDI can

Increase market competition
Lower prices
 Create greater consumer choice


McGraw-Hill/Irwin
International Business, 5/e
Stimulate capital investments
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-18
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-19
Costs of FDI to host countries




Can drive out local competitors or prevent
their development
Profits brought home ‘hurts’ (debit) a host’s
capital account
Parts imported for assembly hurt trade balance
Can affect sovereignty and national defense
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-20
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-21
Home country problems with FDI

Negative effect on Balance of Payments




Initial capital outflow
MNC uses foreign subsidiary to sell back to
home market
MNC uses foreign subsidiary as a substitute
for direct exports
Potential loss of jobs
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-22
Government incentives for FDI





Risk insurance (Home)
Elimination of double taxation (Home)
Tax incentives (Host)
Low interest rates (Host)
Stable government and stable policies
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-23
Government disincentives for 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)
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-24
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
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-25
The four Cs of negotiation
Fig 7.1
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.
7-26
Determinants of bargaining power
McGraw-Hill/Irwin
International Business, 5/e
© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved.