Chapter 7 Outline

Introduction

Chapter 6 looked at the phenomenon of foreign direct investment (FDI) and reviewed several theories that attempt to explain the economic rationale for FDI, but it did not discuss the role of governments in FDI. Through their choice of policies, governments can both encourage and restrict FDI. Host governments can encourage FDI by providing incentives for foreign firms to invest in their economies, and they can restrict FDI through a variety of laws and policies. The opening case illustrated how the French government provided incentives that helped induce Toyota to set up an automobile plant in that country.

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. For example, in response to a belief that the Iranian government actively supports terrorist organizations, the US government has prohibited US firms from investing in or exporting to Iran.

Historically, one important determinant of a government's policy toward FDI has been its political ideology. Accordingly, this chapter opens with a discussion of how political ideology influences government policy. To a greater or lesser degree, the officials of many governments tend to be pragmatic nationalists who weigh the benefits and costs of FDI and vary their stated policy on a case-by-case basis. After discussing political ideology, we will consider the benefits and costs of FDI. Then we will look at the various policies home and host governments adopt to encourage and/or restrict FDI. The chapter closes with a detailed discussion of the implications of government policy for the business firm. In this closing section, we examine the factors that determine the relative bargaining strengths of a host government and a firm contemplating FDI. We will look at how the negotiations between firm and government are often played out and at how firms can use this knowledge to their advantage.