Chapter 7 Outline

The Benefits and Costs of FDI to Home Countries

FDI also produces costs and benefits to the home (or source) country. Does the US economy benefit or lose from investments by its firms in foreign markets? Does the Japanese economy lose or gain from Toyota's investment in France? Some argue that FDI is not always in the home country's national interest and should be restricted. Others argue that the benefits far outweigh the costs and any restrictions would be contrary to national interests. To understand why people take these positions, let us look at the benefits and costs of FDI to the home (source) country.¹²

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. Thus, one benefit to Japan from Toyota's investment in France are the earnings that are subsequently repatriated to Japan from France. FDI can also benefit the current account of the home country's balance of payments if the foreign subsidiary creates demands for home-country exports of capital equipment, intermediate goods, complementary products, and the like.

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. Thus, Toyota's investment in auto assembly operations in Europe has benefited both the Japanese balance-of-payments position and employment in Japan, because Toyota imports some component parts for its European-based auto assembly operations directly from Japan.

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.¹³ For example, one reason General Motors and Ford invested in Japanese automobile companies (GM owns part of Isuzu, and Ford owns part of Mazda) was to learn about their production processes. If GM and Ford are successful in transferring this know-how back to their US operations, the result may be a net gain for the US economy.

Costs of FDI to the Home Country

Against these benefits must be set the apparent costs of FDI for the home (source) 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. Thus, insofar as Toyota's assembly operations in the United States are intended to substitute for direct exports from Japan, the current account position of Japan will deteriorate.

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 (as was the case in both Japan and the United States during the 1980s), this concern may not be that great. However, if the home country is suffering from unemployment, concern about the export of jobs may arise. For example, one objection frequently raised by US labor leaders to the free trade pact between the United States, Mexico, and Canada (see the next chapter) is that the United States will lose hundreds of thousands of jobs as US firms invest in Mexico to take advantage of cheaper labor and then export back to the United States market.¹⁴

International Trade Theory and Offshore Production

When assessing the costs and benefits of FDI to the home country, keep in mind the lessons of international trade theory (see Chapter 4). International trade theory tells us that home-country concerns about the negative economic effects of offshore production may be misplaced. The term offshore production refers to FDI undertaken to serve the home market. Far from reducing home-country employment, such FDI may actually stimulate economic growth (and hence employment) in the home country by freeing up home-country resources to concentrate on activities where the home country has a comparative advantage. In addition, home-country consumers benefit if the price of the particular product falls as a result of the FDI. Also, if a company were prohibited from making such investments on the grounds of negative employment effects while its international competitors reaped the benefits of low-cost production locations, it would undoubtedly lose market share to its international competitors. Under such a scenario, the adverse long-run economic effects for a country would probably outweigh the relatively minor balance-of-payments and employment effects associated with offshore production.