The Political Economy Of Foreign Direct Investment Chapter 7 The Political Economy Of Foreign Direct Investment

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

Political ideology and FDI Radical View Pragmatic Nationalism Free Market

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

Radical view Radical view was popular (1945-80) among Communist countries (China, Cuba) Socialist countries in Africa Nationalistic countries (Iran, India)

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

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

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

Three main ideological positions regarding FDI

Benefits of FDI to host countries Resource-transfer effects Capital Technology Management Employment effect Direct indirect

Benefits of FDI to host countries Balance-of-payments effect. Current account-surplus/deficit Capital account Increases competition and spurs economic growth

Resource-transfer effects Capital Technology Management

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

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

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

U.S. Balance of payments accounts

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 Stimulate capital investments

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

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

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

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

Government incentives for FDI Risk insurance (Home) Elimination of double taxation (Home) Tax incentives (Host) Low interest rates (Host) Stable government and stable policies

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)

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

The four Cs of negotiation Fig 7.1

Determinants of bargaining power