Part Five

The Dynamics of International Business-Government Relationships


Chapter 11

Government Attitudes Toward

Foreign Direct Investment





!          Examine the conflicting objectives of MNE stakeholders.

!          Discuss problems in evaluating the activities of MNEs.

!          Evaluate the major economic impacts—specifically, balance of payments and growth—of MNEs on home and host countries.

!          Provide an overview of the major political controversies surrounding the activities of MNEs.



Chapter Overview


Government policies both encourage and restrict foreign direct investment activities. Chapter 11 examines the major assertions about MNE practices, as well as the evidence supporting or refuting those assertions. It begins by discussing the impact of FDI among stakeholders both at home and abroad, and notes the inevitable trade-offs that must be considered. It then explores the economic impact of foreign direct investment in terms of its balance of payments, economic growth and employment effects. The chapter concludes with a discussion of the major legal and political controversies of FDI.



Chapter Outline


OPENING CASE: Foreign Direct Investment in China [See Map 11.1]

This case details China’s “love-hate” relationship with foreign direct investment. Since 1993, China has ranked second to the United States for FDI inflows among all countries. Japan, Taiwan and the U.S. are China’s largest sources of FDI. Until the mid-1990s, China required most foreign firms to agree to an equity joint venture with a local partner as a condition of market access. MNEs are attracted to China because of its market potential of 1.3 billion people, increasing purchasing power, improving infrastructure, relatively inexpensive natural and labor resources, and strategic position within the global economy. Over time, the Chinese government has begun to encourage FDI—but only in certain sectors of the economy, and subject to evolving constraints. Foreign firms welcomed China’s joining the World Trade Organization because the required policy changes would largely be to their benefit. It remains to be seen, however, how China interprets and enforces its WTO commitments. Its long march toward an open-market economy will surely be a challenging one as ideological legacies serve as obstacles to block its path.


Teaching Tip: Review the PowerPoint slides for Chapter 11 and select those you find most useful for enhancing your lecture and class discussion. For additional visual summaries of key chapter points, review the figures and table in the text. Also, note the reference to the CultureQuest video at the end of the chapter’s closing case.


I.                   INTRODUCTION

Government policies both encourage and restrict foreign direct investment flows and operations. A principal concern about FDI is that MNEs’ global orientation will make them insensitive to national interests and concerns. Many MNEs are so large the value of their annual sales exceeds the GNP of certain countries. Because of their considerable power, the executives of MNEs often deal directly with heads of state when negotiating the terms under which their firms will conduct operations.



Although many governments have moved from a position of opposition to one of suspicion to one of cooperation regarding FDI, the relevant benefits and costs must always be weighed in light of the concerns of a variety of stakeholders.

A.                Trade-off among Constituencies

Stakeholders represent those parties directly or indirectly affected by an organization’s activities. They include stockholders, employees, customers, suppliers, governments, competitors and society at large. Each group will likely have different interests and priorities, which may vary from country to country as well. The principal difficulty for MNEs lies in the challenges that arise from trying to serve multiple interest groups while maximizing the performance of the firm.

B.                 Trade-offs among Objectives

The effects of an MNE’s activities may be simultaneously positive with respect to one national objective and negative for another. Thus, countries must recognize both the associated costs and benefits. Further, even when all parties gain, they may ultimately disagree over the equitable distribution of benefits.

C.                Cause-Effect Relationships

Opponents of FDI try to link the actions of MNEs to matters such as inequitable income distribution, political corruption, environmental debasement and societal deprivation. Proponents, on the other hand, view MNEs as sources of increased tax revenues, higher employment, technology, innovation and exports. However, it is very difficult to determine the true cause-effect relationship of FDI because competitors’ actions, technological developments and government policies all serve to intervene.

D.                Individual and Aggregate Effects

Whether evaluating foreign investments on an individual or an aggregate basis, it is very difficult to assess their impact. This is because the philosophy, actions and goals of each MNE are quite unique.

E.                 Potential Contributions of MNEs

The sheer scale of MNEs means they have assets that can ultimately contribute to a wide range of national objectives. MNEs not only control a large portion of the world’s assets, but they account for most of the world’s imports and exports of goods and services and are also major producers and organizers of technology. Thus, MNEs can directly contribute to a host country’s national objectives in the areas of investment, human resources, technology, trade and the environment.



Multinational enterprises affect countries’ economies in a variety of ways. Effects may be positive or negative for both the home and the host countries.

A.                Balance-of-Payments Effects

Ultimately, FDI inflows may lead to increased exports for a country via the import-substitution effect. Nonetheless, FDI can lead both to capital inflows and outflows as well as a net balance-of-payments effect that is either positive or negative.

1.                  Place in the Economic System. When a country runs a long-term trade deficit, it must compensate either by reducing its capital reserves (or borrowing) or by attracting an influx of capital. Countries’ attempts to regulate trade and investment flows through incentives, prohibitions and other types of government intervention will influence firms’ investment and operating decisions and strategies.

2.                  Effects of Individual FDI. Both home and host governments need to assess the effects of individual and aggregate FDI movements. Although the formula to do so is relatively simple, the data used must be estimated and are subject to assumptions; therefore, the formula must be used with caution. The equation for the potential balance-of-payments effect of FDI is:

B = (m - m1) + (x - x1) + (c - c1)

where B = balance of payments effect, m = import displacement, m1 = import stimulus, x = export stimulus, x1 = export reduction, c = capital inflow for other than import and export payment, and c1 = capital outflow for other than import and export payment. The marginal propensity to import principle states that the recipients of increased incremental income will spend some portion of it on imports. The net import change (m - m1), the net export effect (x - x1) and the net capital flow combine to determine the effect of FDI on a country’s balance of payments.

3.                  Aggregate Assumptions and Responses. Initially, the balance-of-payments effects of FDI are generally positive for the host country and negative for the home country. Therefore, home countries may attempt to establish outflow restrictions, while host countries may impose repatriation restrictions, asset-valuation controls and other forms of constraints.

B.                 Growth and Employment Effects

Although stakeholders in both home and host countries may gain from FDI, some constituencies may argue they are economic losers. However, when a firm establishes a foreign production facility to serve foreign markets and does so without decreasing resource employment at home, both home and host countries may benefit.

1.                  Home-country Losses. Home countries may be disadvantaged when firms outsource production to foreign subsidiaries. Not only are jobs exported, but home country wages and benefits may also be reduced. In addition, critical technology and other proprietary information are often transferred abroad.

2.         Host-country Gains. Host countries generally gain through the receipt of FDI because it stimulates local development through the employment of idle resources. In addition to the gains of capital, technology and employment, the upgrading of resources may also lead to increased productivity and competitiveness within the nation.

3.                  Host-country Losses. Host countries may lose if investments by MNEs replace local firms, attract the best resources, discourage local entrepreneurship and/or decrease local research and development. By increasing the demand for scarce labor, wages may be driven up, thus further challenging local competitors.

4.         General Conclusions. Not all MNE activities have the same effect on growth in the home or host countries. However, FDI is likely to make a positive contribution in a host country when FDI is not a substitute for domestic investment, the product or process technology is highly differentiated and scarce resources not locally available can be accessed.



Another major concern about MNEs is that because the majority of their sales and assets tend to be located in their home countries, the firms will function as foreign-policy instruments of their governments. Critics are also concerned that because many MNEs are so large, they will be beyond the control of either home or host country.

A.        Extraterritoriality

Extraterritoriality refers to the situation under which governments extend their laws to the foreign operations of their domestic firms. In some instances, home country laws may conflict with those of a firm’s host country.

1.                  Trade Restrictions. The primary focus of this criticism has been upon the U.S. government’s attempts to apply its Trading with the Enemy Act to the foreign subsidiaries of U.S. firms in order to prevent them from selling to or sourcing from unfriendly countries. Both the Cuban Democracy Act of 1992 and the Helms-Burton Act have also led to strong disapproval from other countries.

2.                  Antitrust Laws. A recurring problem for U.S. firms has been the ambiguity of the U.S. antitrust policy regarding their relationships with other companies abroad and the possible resulting harm to home-country firms and consumers. In the past, the U.S. government has acted against U.S. firms whenever it had concerns about their participating in (international) cartels that set prices or production quotas, their granting of exclusive distributorships abroad and/or their forming joint research and development or manufacturing operations in foreign countries.

B.                 Key Sector Control

Closely related to the extraterritoriality issue is the fear that if foreign-owned firms dominate key national industries (those industries that affect a large segment of the population by virtue of their size or influence), decisions made outside of the country may have adverse economic and/or political effects in the host country. MNE home country headquarters often decide what, where and how their foreign subsidiaries will operate. Although various countries have selectively prevented the foreign domination of key industries, they have quite different ideas as to the definition of “key.” Special concern surrounds foreign government-owned enterprises that participate in foreign direct investment activities abroad.

C.                MNE Independence

Some observers worry MNEs play one country against another (and that countries join their game) and thereby evade regulation by all countries. Similarly, they worry MNEs play states or provinces within a particular country against each other. In addition, MNEs may develop ownership structures that minimize their payment of taxes anywhere. However, once a firm has committed fixed assets to a foreign subsidiary, it is less likely to abandon its operations there than previously.

D.                Host-Country Captives

Many MNEs have lobbied their home country governments to adopt policies more amenable to the foreign countries where they operate. Often the firms fear retaliation against home-country trade sanctions.

E.                 Bribery [See Table 11.1 and Figure 11.4]

Bribery influences the performance of both countries and companies. Anecdotal information indicates questionable payments by MNEs to government officials have been prevalent in both industrial and developing countries. High levels of corruption tend to correlate with lower growth rates and lower levels of per-capita income. Also, corruption may erode the legitimacy of a government. Bribery occurs for a variety of reasons and takes many forms. The Foreign Corrupt Practices Act of 1997 appears to be a useful deterrent, although an apparent inconsistency permits payments to foreign officials to expedite their compliance with the law, but not to other officials not responsible for carrying out the law.



Countries tend to be more concerned about large foreign corporations than small ones. In fact, governments of developing countries may actually prefer small firms because of their better fit with local concerns and needs. In theory, host countries may take positions toward MNEs that range from completely restrictive to laissez-faire; in actuality, national policies tend to lie somewhere between the two extremes and ebb and flow over time. To further complicate the issue, the perception of a given company’s operations in one country may affect the perceptions of its stakeholders in other countries. As a firm expands the geographical scope of its operations, the odds of negative perceptions regarding its impact are likely to increase.



Are Some Bribes Justifiable?

Both the Foreign Corrupt Practices Act and the OECD Bribery Convention are designed to stop the practice of bribing foreign officials and executives, but many complain that while businesses are forbidden to engage in such practices, governments often do. Thus, companies have devised their own legal means to influence those same parties—indirectly. The question is whether any of these actions is justifiable. Can unethical “means” ever justify a desirable “end” with respect to an international business transaction? Further, there is the issue of foreign firms’ contributions to local political parties in host countries. Can political donations made to ensure host country policies will be formulated according to the interests of foreign firms ever be justified?



Will FDI Be Welcome as the 21st Century Progresses?

In all likelihood, governments will continue to aggressively compete for a larger share of the investment flows and benefits generated by the presence of MNEs in their countries, although some will simultaneously impose strict regulations. Also, some will choose to fault FDI as the cause of their country’s increasing poverty, loss of sovereignty, cultural disintegration and whatever other malady may be affecting their society. Control will continue to be an issue. At the dawn of a new century, MNEs may be forced to heed calls by both home and host governments to make their decision processes more transparent.




Teaching Tip: Visit for additional information and links relating to the topics presented in Chapter 11. Be sure to refer your students to the on-line study guide, as well as the Internet exercise for Chapter 11.



CLOSING CASE: FDI in South Africa [See Map 11.2, plus reference to CultureQuest video.]


1.         What are the costs and benefits to South Africa of having more foreign direct investment? of having less?

The fact that the South African Reserve Bank considers FDI inflows a “prerequisite for faster economic growth and development” illustrates the expectation the benefits will significantly outweigh the costs. Primary benefits would include:

·         the creation of jobs

·         capital inflows

·         the transfer of technology

·         the transfer of skills

·         the diversification of the economy

·         improved productivity

·         import substitution

·         increased exports, and hence, an overall improvement in South Africa’s balance of payments account.

Costs would primarily be related the type of FDI that might be attracted (e.g., acquisition vs. newly built operations), the potential harm to the natural and cultural environments as a result of the industrialization process and the potential influence of foreign firms on South Africa’s domestic policies.


2.                  How might a company try to weigh fairly the opportunities and threats of investing in South Africa?

A firm should initially investigate the economic, cultural and political environments in South Africa in light of its own mission, objectives and operations. Given a positive result, it should then specifically assess its potential investment (either resource-seeking or market-seeking) in light of local competition, as well as the government’s attitude with respect to foreign direct investment in that particular industry. A firm should carefully examine its own expectations with respect to the potential benefits and costs of the venture and match them to the South African government’s expectations and requirements for such an investment. The firm may also wish to calculate the venture’s potential contribution to the country’s balance-of-payments account by applying the following formula: B = (m - m1) + (x - x1) + (c - c1).


3.                  If South Africa is to receive more foreign direct investment, how should it prioritize policies to attract it?

First and foremost, political and economic stability are critical if South Africa expects to attract foreign direct investment. Given that, it is vital the policies developed to attract FDI reflect the economic priorities of the South African government. To quickly create employment, the government should target investment in labor-intensive industries. To build infrastructure (e.g., water, electricity and telecommunications projects), it should privatize existing government-controlled firms and also allow for increased foreign competition in these industries. Further, South Africa’s FDI policy should remain quite consistent over time and be very competitive when compared to policies offered by similar countries. Finally, the government needs to promote the long-term development of a stable, reliable and well-trained workforce.


4.                  Assume you work for a non-South African company and are in charge of identifying countries where your company might expand. What factors would you consider when comparing South Africa with other developing countries? What about in terms of developed markets?

Whether considering resource-seeking or market-seeking investments, the factor of distance will certainly come into play with respect to South Africa. While it is strategically located for sourcing from or serving the markets of southern Africa, it is at a distinct disadvantage with respect to the distances to other markets or sources of supply. In the final analysis, firms will presumably select those investments that provide the best returns. In addition to political and economic stability, government policies, incentives and restrictions will also be critical factors. South Africa has much to offer in terms of both market-seeking and resource-seeking investments. When compared to a developed country, South Africa offers extensive natural resources and a growing market; per capita income, however, is significantly lower, and while the available workforce is large, it is generally not as highly skilled as the workforce in a developed nation. In addition, neither its infrastructure nor its financial system is as extensively developed as that of an industrialized nation.



Additional Exercises: Government Attitudes Toward FDI


Exercise 11.1. Identify the various home countries of students in your class. Then lead the class in a comparative discussion of the importance of foreign direct investment in their home countries. To what extent do their governments encourage it? In what ways do they encourage it? If there are regulations, what are they? What MNEs have foreign subsidiaries there? Conclude by asking the students to discuss both the positive and negative effects of foreign direct investment on their national economies and cultures.


Exercise 11.2. Political ideologies can have a major impact upon the foreign direct investment policies of nations. Ask students to debate the following idea:

The continuing liberalization of foreign direct investment policies and activities by developing countries will necessarily move those nations toward democracy.


Exercise 11.3. All countries have trade and investment policies, which have grown in importance as trade and investment flows have become more and more relevant to the well being of most nations. Ask students to discuss the impact of foreign direct investment upon a country’s international trade activities. Is it in a country’s best interest to encourage one at the expense of the other? Explain. Be sure to incorporate the span of potential stakeholders in the coverage of the discussion.