Fourth Edition

1. International Business Fourth Edition

2. CHAPTER 7 The Political Economy of Foreign Direct Investment

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.

4. Radical View Pragmatic Nationalism Free Market Political Ideology and FDI

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 countriesembracing capitalism.

6. Free Market View • Roots in Smith and Ricardo. • International production should be distributed among countries according to thetheory 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.

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.

8. Ideology Characteristics Host-Government Policy Implications Radical Prohibit FDI Marxist roots Nationalize subsidiaries of Views the MNE as an instrument of imperialist foreign-owned MNEs domination Classical economic roots (Smith) Free Market Views the MNE as an instrument for allocating production to most efficient locations Pragmatic Views FDI as having both Restrict FDI where costs outweigh benefits Nationalism benefits and costs Bargain for greater benefits and fewer costs Aggressively court beneficial FDI by offering incentives Political Ideology Toward FDI No restrictions on FDI Table 7.1

9. Resource-Transfer Effects Direct Employment Effects Indirect Capital Technology Balance-of-Payments Effects Management Benefits of FDI to Host Countries

10. US Balance-of-Payments Accounts 2000 $Millions Table 7.2

11. Current Account Deficitoccurs when imports are greater than exports. Current Account Surplusoccurs when exports are greater than imports. Capital Account records transactions that involve the purchase or sale of assets. 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. FDI and Balance-of-Payments

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.

13. Adverse Effects on Competition Adverse Effects on the Balance of Payments Adverse Effects on Sovereignty and Autonomy Drive out local competitors Earnings & imports hurt capital account Key economic decisions made by ‘foreigners’ Costs of FDI to Host Countries

14. Inward flow of earnings Increased knowledge Creates export demand Balance of Payments hurt Potential reduction in home country employment Initial capital outflow Substitute for exports Sells back to home market Benefits and Costs of FDI to Home Countries

15. International Trade Theory and FDI • Home-country concerns aboutoffshore productionmay 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.

16. Encourage Outward FDI Government backed risk insurance. Government loans. Eliminate double taxation. Political persuasion to relax restrictions on inbound FDI. Restricting Outward FDI Limit capital outflows. Use tax code to encourage companies to stay home. Prohibitions against investing in certain countries (Cuba, Libya, Iran). Government Policy Instruments and FDI Home Country Policies

17. Encourage Inward FDI Offer investment incentives. Tax concessions. Low-interest loans. Grant/subsidies. Attempt to attract investment away from other countries. 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 Government Policy Instruments and FDI Host Country Policies

18. International Institutions and the Liberalization of FDI WTO OECD Developed nations have had problems agreeing on rules. Developing nations have been reluctant to agree to liberalization.

19. Common Interests Conflicting Interests Negotiation Process Compromise Criteria The Context of NegotiationThe four Cs Compromise Figure 7.1

20. Long Short Firms time horizon Comparable alternatives open to firm Many Few Value placed by host government on investment High Low Determinants of Bargaining Power Bargaining Power of Firm High Low Table 7.3