FOREIGN DRUG
PROHIBITION, THE MNE’S
FDI DECISION AND HOME
COUNTRY INSTITUTIONAL
STABILITY
Ram Mudambi, Temple University
Chris Paul, Georgia Southern University
Prepared for presentation at the 3rd IGMS Research Forum
Philadelphia, PA
March 2002
OBJECTIVE
• Employ the O-L-I paradigm to identify
the determinants of the location
decisions of the Extra-legal Enterprise
(XLE)
• Apply research findings from the
prohibition and rent-seeking literatures
to determine implications for the home
and host countries
© Mudambi, Temple / Paul, Georgia Southern, 2002
2
The O-L-I paradigm* – 1
• Ownership: Firm specific advantages that
emanate from the ownership or control of a
resource
• For the XLE the risk of expropriation means
that it will prefer to control resources that
are legally owned by others. As the XLE
possesses enforcement or coercive
capabilities, most of the disadvantages of
surrogate ownership are mitigated.
* (Dunning 1977)
© Mudambi, Temple / Paul, Georgia Southern, 2002
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The O-L-I Paradigm – 2
• Location: Resources, networks and
institutions that are immovable and countryspecific.
– Natural resources and climate (Rugman and
Gestrin, 1993)
– Wages and salary levels
– Culture (Dunning, 1988)
– Political risk (Mudambi, 2002)
© Mudambi, Temple / Paul, Georgia Southern, 2002
4
The O-L-I Paradigm – 3
• Internalization: Results from reducing
transaction costs by internalizing a market
operation.
• Market imperfections (Buckley and Casson,
1976)
– Government regulations or prohibitions
– Poorly organized markets
– Asymmetric information
© Mudambi, Temple / Paul, Georgia Southern, 2002
5
Prohibition and Internalization
• Prohibition increases incentives to
internalize market operations
– Prohibited status of the product /service
increases the relative costs of external markets
(Dick, 1995)
– Gains to internalization are enhanced by
economies of scale in the provision of coercion
(Rubin, 1973).
© Mudambi, Temple / Paul, Georgia Southern, 2002
6
Prohibition, Institutions and
Behavior
• Rents: Any payment in excess of opportunity
costs
– A Peruvian farmer makes $1/kg with legal crops and
$3.5/kg for coca, receiving a rent of $2.5/kg.
• Rents increase with (a) a higher discount rate;
(b) a lower wage rate; (c) lower risk aversion
• The higher the rents from an activity, the
greater will be the rents from entrepreneurship
or corruption based on this activity (Cadot,
1987).
© Mudambi, Temple / Paul, Georgia Southern, 2002
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Rent seeking and Legal Status – 1
• Rent seeking: Expending resources to increase the
probability of capturing an existing prize, when
competition results in behaviors that generate
social waste (Buchanan, 1980)
• In legal markets – Stigler’s (1971) capture theory
of regulation
– Reduce quantity, restrict entry to create monopoly rents
• In illegal markets – Prohibition artificially reduces
quantity
– This creates rents and eliminates state enforced
property rights
© Mudambi, Temple / Paul, Georgia Southern, 2002
8
Rent seeking and Legal Status – 2
• Illegal markets provide an opportunity to
study the social consequences of the
absence of property rights. Alchian and
Demsetz (1973)
• “As a result of government prohibition”
drugs are “extraordinarily profitable for
producers and traffickers.” Bertram, et al,
(1996)
© Mudambi, Temple / Paul, Georgia Southern, 2002
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Results of private provision of
property rights by the XLE
• Violence: Rent seeking and rent defending
in the absence of due legal process
• Corruption: Rent seeking by political
office holders
• Retarded economic development: Reallocation of resources to non-productive
uses
• Institutional instability: Externalities
© Mudambi, Temple / Paul, Georgia Southern, 2002
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The MNC - FDI effects Repatriated
Taxes, tariffs
and other
payments
to the govt.
HOST
Inflow of
capital, inputs
Subsidiary
profits
HOME
Parent
Exports
3rd
Country Spillover of
technology and
management
practices
Suppliers
Local
net jobs
created – Followdirect, the-leader
indirect exports
© Mudambi, Temple / Paul, Georgia Southern, 2002
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Home
jobs
created
The XLE - FDI effects
Increased costs, prices Inflow of
due to interdiction capital, inputs
Subsidiary
Repatriated
rents, profits
Parent
HOST
HOME
Spillover of
operational and
management
practices
Home
Local
Resource
job market Misallocation
distortion –
direct,
Institutional
indirect
effects
© Mudambi, Temple / Paul, Georgia Southern, 2002
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Home
job market
distortion
Coercive
business environment
Local Labor
Market
Rent-seeking,
Corruption
Judiciary,
Government
agencies
Business
Policies
Rent payments
Repatriated
rents
Legal
(Controlled)
Enterprises
XLE
Parent
Patronage,
Rents
HOME COUNTRY
GOVERNMENT
Diverted labor supply
Output
RentSeeking,
Corruption
Enforcement
agencies
Prohibition
Policy
© Mudambi, Temple / Paul, Georgia Southern, 2002
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XLE
Subsidiary