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 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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7-3
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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7-4
Ideology and 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
locations
No restrictions on FDI
Pragmatic
Nationalism
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
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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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
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
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May-98
1996
1994
1992
1990
1988
1986
1984
1982
0
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 company’s 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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