International
Business
Fourth Edition
CHAPTER 7
The Political Economy of Foreign
Direct Investment
7-3
Chapter Focus
This chapter examines the role of
government in FDI.
Through its actions, governments can
encourage or discourage FDI by providing
investment incentives or passing
laws/implementing policies that restrict
foreign investment.
Political ideology influences government
policy.
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7-4
Political Ideology and FDI
Radical
View
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Pragmatic
Nationalism
Free
Market
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7-5
Radical View
Marxist roots.
An instrument of imperialist domination.
Exploit host country for the benefit of the MNE.
Keeps less developed countries relatively backward and dependent
on capitalist nations for investment, jobs, and technology.
Influential from 1945 to the 80s.
Eastern Europe, China, Cuba, some African countries, Iran, and
India.
Failure.
Collapse of Communism.
Poor economic performance.
Strong economic performance of countries embracing capitalism.
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7-6
Free Market View
Roots in Smith and Ricardo.
International production should be distributed among
countries according to the theory of competitive advantage.
Positive changes in laws and growth of bilateral agreements
attest to strength of free market view.
However, all governments, to some degree, intervene in the
free market.
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7-7
Pragmatic Nationalism
View FDI as having both benefits and costs.
Governments tend toward FDI when benefits versus
costs are high.
Aggressively court FDI that has national interest
ramifications, typically through tax breaks or grants.
Technology.
Employment.
Balance of payment benefits.
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7-8
Political Ideology Toward FDI
Ideology
Characteristics
Host-Government Policy
Implications
Radical
Marxist roots
Views the MNE as an
instrument of imperialist
domination
Prohibit FDI
Nationalize subsidiaries of
foreign-owned MNEs
Free
Market
Classical economic roots (Smith)
Views the MNE as an
instrument for allocating
production to most efficient
No restrictions on FDI
locations
Pragmatic
Nationalism
Table 7.1
McGraw-Hill/Irwin
Views FDI as having both
benefits and costs
Restrict FDI where costs
outweigh benefits
Bargain for greater benefits
and fewer costs
Aggressively court beneficial
FDI by offering incentives
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7-9
Benefits of FDI to Host Countries
Direct
Resource-Transfer
Effects
Capital
Technology
Employment
Effects
Indirect
Balance-of-Payments
Effects
Management
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US Balance-of-Payments Accounts 2000
$Millions
Current Account
Credits
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
$1,069,531
7-10
Debits
773,304
296,227
345,394
$-1,797,061
-1,222,772
-215,239
-359,050
-53,241
-435,377
Capital Account
Table 7.2
US assets abroad (net)
Foreign assets in the US
952,430
Balance on capital account
399,081
Statistical discrepancy
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-553,349
35,616
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7-11
FDI and Balance-of-Payments
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.
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3 B-of-P Consequences:
When MNE establishes
its foreign subsidiary, the
host country benefits
from initial capital inflow.
If the FDI is a substitute
for imports, it improves
the host country’s balance
of payments.
Subsidiary is used for
exports.
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7-12
Effect on Competition and Economic
Growth
FDI can:
Increase market competition.
Lower prices.
Greater consumer choice.
Stimulate capital investments.
Increase:
Productivity.
Product/process innovation.
Economic growth.
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Costs of FDI to Host Countries
Adverse Effects
Adverse Effects
on
on the
Competition
Balance of Adverse Effects
on
Payments
Drive out
Sovereignty
local
and
competitors
Earnings &
Autonomy
imports hurt
capital
account
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Key economic
decisions made
by ‘foreigners’
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7-14
Benefits and Costs of FDI to Home
Countries
Inward
flow of
earnings
Initial
capital
outflow
McGraw-Hill/Irwin
Balance
of
Payments
hurt
Creates
export
demand
Increased
knowledge
Potential
reduction
in home
Substitute
Sells
country
for
back to exports
employment
home
market
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7-15
International Trade Theory and
FDI
Home-country concerns about offshore production
may be misplaced.
Offshore production refers to FDI undertaken to
serve the home market.
May increase employment by freeing home country
resources to concentrate on activities where the
home country has a competitive advantage.
May lead to lower prices for consumers.
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7-16
Government Policy Instruments and FDI
Home Country Policies
Encourage Outward FDI
Government backed risk
insurance.
Government loans.
Eliminate double
taxation.
Political persuasion to
relax restrictions on
inbound FDI.
McGraw-Hill/Irwin
Restricting Outward FDI
Limit capital outflows.
Use tax code to
encourage companies to
stay home.
Prohibitions against
investing in certain
countries (Cuba, Libya,
Iran).
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7-17
Government Policy Instruments and
FDI
Host Country Policies
Encourage Inward FDI
Offer investment
incentives.
Tax concessions.
Low-interest loans.
Grant/subsidies.
Attempt to attract
investment away from
other countries.
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Restricting Inward FDI
Ownership restraints.
Excluded from specific
fields.
National security.
Competition.
Restrictions on amount
of ownership.
Performance requirements.
Local content.
Technology transfer.
Local participation in
management
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7-18
International Institutions and the
Liberalization of FDI
WTO
OECD
Developing nations
have been reluctant
to agree to
liberalization.
Developed nations
have had problems
agreeing on rules.
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7-19
The Context of Negotiation
The four Cs
Common
Conflicting
Interests
Interests
Negotiation
Process
Compromise
Compromise
Figure 7.1
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Criteria
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7-20
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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