Chapter 7 Outline

Political Ideology and Foreign Direct Investment

Historically, ideology toward FDI has ranged from a dogmatic radical stance that is hostile to all FDI at one extreme to an adherence to the noninterventionist principle of free market economics at the other. Between these two extremes is an approach that might be called pragmatic nationalism. The spectrum is shown in Figure 7.1, and we will review each of these approaches in turn.

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. They note, for example, that key technology is tightly controlled by the MNE, and that important jobs in the foreign subsidiaries of MNEs go to home-country nationals rather than to citizens of the host country. Because of this, according to the radical view, FDI by the MNEs of advanced capitalist nations keeps the less developed countries of the

Figure 7.1

The Spectrum of Political Ideology toward FDI

world relatively backward and dependent on advanced capitalist nations for investment, jobs, and technology. 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.¹

From 1945 until the 1980s, the radical view was very influential in the world economy. Until the collapse of communism between 1989 and 1991, the countries of Eastern Europe were opposed to FDI. Similarly, communist countries elsewhere, such as China, Cambodia, and Cuba, were all opposed in principle to FDI (although in practice the Chinese started to allow FDI in mainland China in the 1970s). The radical position was also embraced by many socialist countries, particularly in Africa where one of the first actions of many newly independent states was to nationalize foreign-owned enterprises. The radical position was further embraced by countries whose political ideology was more nationalistic than socialistic. This was true in Iran and India, for example, both of which adopted tough policies restricting FDI and nationalized many foreign-owned enterprises. Iran is a particularly interesting case because its Islamic government, while rejecting Marxist theory, has essentially embraced the radical view that FDI by MNEs is an instrument of imperialism.

By the end of the 1980s, however, the radical position was in retreat almost everywhere. There seem to be three reasons for this: (1) the collapse of communism in Eastern Europe; (2) the generally abysmal economic performance of those countries that embraced the radical position, and a growing belief by many of these countries that FDI can be an important source of technology and jobs and can stimulate economic growth; and (3) the strong economic performance of those developing countries that embraced capitalism rather than radical ideology (e.g., Singapore, Hong Kong, and Taiwan).

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 (see Chapter 4). The intellectual case for this view has been strengthened by the market imperfections explanation of horizontal and vertical FDI that we reviewed in Chapter 6. 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 globe. Viewed this way, FDI by the MNE increases the overall efficiency of the world economy.

Consider a well-publicized decision by IBM in the mid-1980s to move assembly operations for many of its personal computers from the United States to Guadalajara, Mexico. IBM invested about $90 million in an assembly facility with the capacity to produce 100,000 PCs per year, 75 percent of which were exported back to the United States.² According to the free market view, moves such as this can be seen as increasing the overall efficiency of resource utilization in the world economy. Mexico, due to its low labor costs, has a comparative advantage in the assembly of PCs. According to the free market view, by moving the production of PCs from the United States to Mexico, IBM frees US resources for use in activities in which the United States has a comparative advantage (e.g., the design of computer software, the manufacture of high-value-added components such as microprocessors, or basic R&D). Also, consumers benefit because the PCs cost less than they would if they were produced domestically. In addition, Mexico gains from the technology, skills, and capital that IBM transfers with its FDI. Contrary to the radical view, the free market view stresses that such resource transfers benefit the host country and stimulate its economic growth. Thus, the free market view argues that FDI is a benefit to both the source country and the host country.

For reasons explored earlier in this book (see Chapter 2), 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. An example is South Korea, which started dismantling its restrictive regulations governing inward FDI in the mid-1990s. As described in the accompanying Management Focus, foreign firms are starting to affect competition in certain sectors of the Korean economy.

According to the United Nations, between 1991 and 1996 over 100 countries made 599 changes in legislation governing FDI. Some 95 percent of these changes involved liberalizing a country's foreign investment regulations to make it easier for foreign companies to enter markets.³ However, in practice no country has adopted the free market view in its pure form (just as no country has adopted the radical view in its pure form). Countries such as Britain and the United States are among the most open to FDI, but the governments of both countries have a tendency to intervene. Britain does so by reserving the right to block foreign takeovers of domestic firms if the takeovers are seen as "contrary to national security interests" or if they have the potential for "reducing competition." (In practice this right is rarely exercised.) US controls on FDI are more limited and largely informal. As noted earlier, for political reasons, the United States will occasionally restrict US firms from undertaking FDI in certain countries (e.g., Cuba and Iran). In addition, there are some limited restrictions on inward FDI. For example, foreigners are prohibited from purchasing more than 25 percent of any US airline or from acquiring a controlling interest in a US television broadcast network. Since 1989, the government has had the right to review foreign investment on the grounds of "national security."

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.

Recognizing this, countries adopting a pragmatic stance pursue policies designed to maximize the national benefits and minimize the national costs. According to this view, FDI should be allowed only if the benefits outweigh the costs. Japan offers one of the more extreme examples of pragmatic nationalism. Until the 1980s, Japan's policy was probably one of the most restrictive among countries adopting a pragmatic nationalist stance. This was due to Japan's perception that direct entry of foreign (especially US) firms with ample managerial resources into the Japanese markets could hamper the development and growth of their own industry and technology.⁴ This belief led Japan to block the majority of applications to invest in Japan. However, there were always exceptions to this policy. Firms that had important technology were often permitted to undertake FDI if they insisted that they would neither license their technology to a Japanese firm nor enter into a joint venture with a Japanese enterprise. IBM and Texas Instruments were able to set up wholly owned subsidiaries in Japan by adopting this negotiating position. From the perspective of the Japanese government, the benefits of FDI in such cases--the stimulus that these firms might impart to the Japanese economy--outweighed the perceived costs.

Another aspect of pragmatic nationalism is the tendency to aggressively court FDI believed to be in the national interest by, for example, offering subsidies to foreign MNEs in the form of tax breaks or grants. As we saw in the opening case, subsidies in the form of tax breaks were one factor that helped persuade Toyota to build an assembly plant in France as opposed to the United Kingdom. The countries of the European Union often seem to be competing with each other to attract US and Japanese FDI by offering large tax breaks and subsidies. Britain has been the most successful at attracting Japanese investment in the automobile industry. Nissan, Toyota, and Honda now have major assembly plants in Britain and use the country as their base for serving the rest of Europe--with obvious employment and balance-of-payments benefits for Britain.

Summary

The three main ideological positions regarding FDI are summarized in Table 7.1. Recent years have seen a marked decline in the number of countries that adhere to a radical ideology. Although no countries have adopted a pure free market policy stance, an increasing number of countries are gravitating toward the free market end of the spectrum and have liberalized their foreign investment regime. This includes many countries that only a few years ago were firmly in the radical camp (e.g., the former communist countries of Eastern Europe and many of the socialist countries of Africa) and several countries that until recently could best be described as pragmatic nationalists with regard to FDI (e.g., Japan, South Korea, Italy, Spain, and most Latin American countries). One result has been the surge in the volume of FDI worldwide, which, as we noted in Chapter 6, has been growing twice as fast as the growth in world trade. Another result has been a dramatic increase in the volume of FDI directed at countries that have recently liberalized their FDI regimes, such as China, India, and Vietnam.