Introduction
The government of a source country for FDI also can encourage or restrict FDI by domestic firms. In recent years, the Japanese government has pressured many Japanese firms to undertake FDI. The Japanese government sees FDI as a substitute for exporting and thus as a way of reducing Japan's politically embarrassing balance of payments surplus. In contrast, the US government has, for political reasons, from time to time restricted FDI by domestic firms.
Political Ideology and Foreign Direct Investment
The Radical View
The radical view traces its roots to Marxist political and economic theory. Radical writers argue that the multinational enterprise (MNE) is an instrument of imperialist domination. They see the MNE as a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. They argue that MNEs extract profits from the host country and take them to their home country, giving nothing of value to the host country in exchange. Thus, according to the extreme version of this view, no country should ever permit foreign corporations to undertake FDI, since they can never be instruments of economic development, only of economic domination. Where MNEs already exist in a country, they should be immediately nationalized.
The Free Market View
The free market view traces its roots to classical economics and the international trade theories of Adam Smith and David Ricardo.. The free market view argues that international production should be distributed among countries according to the theory of comparative advantage. Countries should specialize in the production of those goods and services that they can produce most efficiently. Within this framework, the MNE is an instrument for dispersing the production of goods and services to the most efficient locations around the globeFor reasons explored earlier in this book, in recent years, the free market view has been ascendant worldwide, spurring a global move toward the removal of restrictions on inward and outward foreign direct investment.
Pragmatic Nationalism
In practice, many countries have adopted neither a radical policy nor a free market policy toward FDI, but instead a policy that can best be described as pragmatic nationalism. The pragmatic nationalist view is that FDI has both benefits and costs. FDI can benefit a host country by bringing capital, skills, technology, and jobs, but those benefits often come at a cost. When products are produced by a foreign company rather than a domestic company, the profits from that investment go abroad. Many countries are also concerned that a foreign-owned manufacturing plant may import many components from its home country, which has negative implications for the host country's balance-of-payments position.
The Benefits of FDI to Host Countries
Resource-Transfer Effects
Capital
Given this tension, the mode for transferring technology--licensing or FDI--can be a major negotiating point between an MNE and a host government. Whether the MNE gets its way depends on the relative bargaining powers of the MNE and the host government.
Management
Foreign management skills acquired through FDI may also produce important benefits for the host country. Beneficial spin-off effects arise when local personnel who are trained to occupy managerial, financial, and technical posts in the subsidiary of a foreign MNE leave the firm and help to establish indigenous firms.
The benefits may be considerably reduced if most management and highly skilled jobs in the subsidiaries are reserved for home-country nationals.
Employment Effects
The beneficial employment effect claimed for FDI is that it brings jobs to a host country that would otherwise not be created there. Cynics note that not all the "new jobs" created by FDI represent net additions in employment. In the case of FDI by Japanese auto companies in the United States, some argue that the jobs created by this investment have been more than offset by the jobs lost in US-owned auto companies, which have lost market share to their Japanese competitors.
Balance-of-Payments Effects
Balance-of-Payments Accounts
A country's balance-of-payments accounts keep track of both its payments to and its receipts from other countries. Any transaction resulting in a payment to other countries is entered in the balance-of-payments accounts as a debit and given a negative ( - ) sign. Any transaction resulting in a receipt from other countries is entered as a credit and given a positive (+) sign.
Balance-of-payments accounts are divided into two main sections: the current account and the capital account. The first category, merchandise trade, refers to the export or import of goods. The second category is the export or import of services. The third category, investment income, refers to income from foreign investments and payments that have to be made to foreigners investing in a country.
A current account deficit occurs when a country imports more goods, services, and income than it exports. A current account surplus occurs when a country exports more goods, services, and income than it imports. The capital account records transactions that involve the purchase or sale of assets. Thus, when a Japanese firm purchases stock in a US company, the transaction enters the US balance of payments as a credit on the capital account. This is because capital is flowing into the country. When capital flows out of the United States, it enters the capital account as a debit.
Thus, any international transaction automatically gives rise to two offsetting entries in the balance of payments. Because of this, the current account balance and the capital account balance should always add up to zero.
Governments normally are concerned when their country is running a deficit on the current account of their balance of payments. When a country runs a current account deficit, the money that flows to other countries is then used by those countries to purchase assets in the deficit country.
FDI and the Balance of Payments
Given the concern about current account deficits, the balance-of-payments effects of FDI can be an important consideration for a host government. There are three potential balance-of-payments consequences of FDI. First, when an MNE establishes a foreign subsidiary, the capital account of the host country benefits from the initial capital inflow. However, this is a one-time-only effect. Set against this must be the outflow of earnings to the foreign parent company, which will be recorded as a debit on the current account of the host country.
Second, if the FDI is a substitute for imports of goods or services, it can improve the current account of the host country's balance of payments. A third potential benefit to the host country's balance-of-payments position arises when the MNE uses a foreign subsidiary to export goods and services to other countries.
Effect on Competition and Economic Growth
Economic theory tells us that the efficient functioning of markets depends on an adequate level of competition between producers. By increasing consumer choice, foreign direct investment can help to increase the level of competition in national markets, thereby driving down prices and increasing the economic welfare of consumers. As we saw in the Management Focus, foreign direct investment has helped increase competition in the South Korean retail sector. The increase in choices, and the resulting fall in prices, clearly benefits South Korean consumers.
The Costs of FDI to Host Countries
Adverse Effects on Competition
Although we have just outlined in the previous section how foreign direct investment can boost competition, host governments sometimes worry that the subsidiaries of foreign MNEs may have greater economic power than indigenous competitors. If it is part of a larger international organization, the foreign MNE may be able to draw on funds generated elsewhere to subsidize its costs in the host market, which could drive indigenous companies out of business and allow the firm to monopolize the market.
In practice, the above arguments are often used by inefficient indigenous competitors when lobbying their government to restrict direct investment by foreign MNEs. Although a host government may state publicly in such cases that its restrictions on inward FDI are designed to protect indigenous competitors from the market power of foreign MNEs, they may have been enacted to protect inefficient but politically powerful indigenous competitors from foreign competition.
Adverse Effects on the Balance of Payments
The possible adverse effects of FDI on a host country's balance-of-payments position have been hinted at earlier. There are two main areas of concern with regard to the balance of payments. First, as mentioned earlier, set against the initial capital inflow that comes with FDI must be the subsequent outflow of earnings from the foreign subsidiary to its parent company. Such outflows show up as a debit on the capital account. Some governments have responded to such outflows by restricting the amount of earnings that can be repatriated to a foreign subsidiary's home country.
A second concern arises when a foreign subsidiary imports a substantial number of its inputs from abroad, which results in a debit on the current account of the host country's balance of payments.
National Sovereignty and Autonomy
Many host governments worry that FDI is accompanied by some loss of economic independence. The concern is that key decisions that can affect the host country's economy will be made by a foreign parent that has no real commitment to the host country, and over which the host country's government has no real control.
The Benefits and Costs of FDI to Home Countries
Benefits of FDI to the Home Country
The benefits of FDI to the home country arise from three sources. First, and perhaps most important, the capital account of the home country's balance of payments benefits from the inward flow of foreign earnings.
Second, benefits to the home country from outward FDI arise from employment effects. As with the balance of payments, positive employment effects arise when the foreign subsidiary creates demand for home-country exports of capital equipment, intermediate goods, complementary products, and the like.
Third, benefits arise when the home-country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country. This amounts to a reverse resource-transfer effect. Through its exposure to a foreign market, an MNE can learn about superior management techniques and superior product and process technologies. These resources can then be transferred back to the home country, contributing to the home country's economic growth rate.
Costs of FDI to the Home Country
Against these benefits must be set the apparent costs of FDI for the home country. The most important concerns center around the balance-of-payments and employment effects of outward FDI. The home country's balance of payments may suffer in three ways. First, the capital account of the balance of payments suffers from the initial capital outflow required to finance the FDI. This effect, however, is usually more than offset by the subsequent inflow of foreign earnings. Second, the current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location. Third, the current account of the balance of payments suffers if the FDI is a substitute for direct exports.
With regard to employment effects, the most serious concerns arise when FDI is seen as a substitute for domestic production. This was the case with Toyota's investments in Europe. One obvious result of such FDI is reduced home-country employment. If the labor market in the home country is already very tight, with little unemployment.
Government Policy Instruments and FDI
Home-Country Policies
Encouraging Outward FDI
Many investor nations now have government-backed insurance programs to cover major types of foreign investment risk. The types of risks insurable through these programs include the risks of expropriation, war losses, and the inability to transfer profits back home. Such programs are particularly useful in encouraging firms to undertake investments in politically unstable countries. In addition, several advanced countries also have special funds or banks that make government loans to firms wishing to invest in developing countries.
Restricting Outward FDI
Virtually all investor countries, including the United States, have exercised some control over outward FDI from time to time. One common policy has been to limit capital outflows out of concern for the country's balance of payments. In addition, countries have occasionally manipulated tax rules to try to encourage their firms to invest at home. The objective behind such policies is to create jobs at home rather than in other nations.
Finally, countries sometimes prohibit national firms from investing in certain countries for political reasons. Such restrictions can be formal or informal.
Host-Country Policies
Encouraging Inward FDI
It is increasingly common for governments to offer incentives to foreign firms to invest in their countries. Such incentives take many forms, but the most common are tax concessions, low-interest loans, and grants or subsidies. Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI. They are also motivated by a desire to capture FDI away from other potential host countries.
Restricting Inward FDI
Host governments use a wide range of controls to restrict FDI in one way or another. The two most common are ownership restraints and performance requirements. Ownership restraints can take several forms. In some countries, foreign companies are excluded from specific fields. The rationale underlying ownership restraints seems to be twofold. First, foreign firms are often excluded from certain sectors on the grounds of national security or competition. Particularly in less developed countries, the feeling seems to be that local firms might not be able to develop unless foreign competition is restricted by a combination of import tariffs and controls on FDI.
Second, ownership restraints seem to be based on a belief that local owners can help to maximize the resource-transfer and employment benefits of FDI for the host country.
International Institutions and the Liberalization of FDI
Until recently there has been no consistent involvement by multinational institutions in the governing of FDI.
However, the WTO has had less success trying to initiate talks aimed at establishing a universal set of rules designed to promote the liberalization of FDI.
Implications for Business
The Nature of Negotiation
The objective of any negotiation is to reach an agreement that benefits both parties. Negotiation is both an art and a science. The science of it requires analyzing the relative bargaining strengths of each party and the different strategic options available to each party and assessing how the other party might respond to various bargaining ploys. The art of negotiation incorporates "interpersonal skills, the ability to convince and be convinced, the ability to employ a basketful of bargaining ploys, and the wisdom to know when and how to use them."
Bargaining Power
The outcome of any negotiated agreement depends on the relative bargaining power of both parties. Each side's bargaining power depends on three factors (see Table 7.3):
· The value each side places on what the other has to offer.
· he number of comparable alternatives available to each side.
· Each party's time horizon.
From the perspective of a firm negotiating the terms of an investment with a host government, the firm's bargaining power is high when the host government places a high value on what the firm has to offer, the number of comparable alternatives open to the firm is great, and the firm has a long time in which to complete the negotiations. The converse also holds. The firm's bargaining power is low when the host government places a low value on what the firm has to offer, few comparable alternatives are open to the firm, and the firm has a short time in which to complete the negotiations.
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