Chapter 7 Outline

The Costs of FDI to Host Countries

Three costs of FDI concern host countries. They arise from possible adverse effects on competition within the host nation, adverse effects on the balance of payments, and the perceived loss of national sovereignty and autonomy.

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. (Once the market was monopolized, the foreign MNE could raise prices above those that would prevail in competitive markets, with harmful effects on the economic welfare of the host nation.) This concern tends to be greater in countries that have few large firms of their own (generally less developed countries). It tends to be a relatively minor concern in most advanced industrialized nations.

Another variant of the competition argument is related to the infant industry concern that we discussed in Chapter 6. We explained that import controls may be motivated by a desire to let a local industry develop to a stage where it can compete in world markets. The same logic suggests that FDI should be restricted. If a country with a potential comparative advantage in a particular industry allows FDI in that industry, indigenous firms may never have a chance to develop.

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. One criticism leveled against Japanese-owned auto assembly operations in the United States, for example, is that they tend to import many component parts from Japan. Because of this, the favorable impact of this FDI on the current account of the US balance-of-payments position may not be as great as initially supposed. The Japanese auto companies have responded to these criticisms by pledging to purchase 75 percent of their component parts from US-based manufacturers (but not necessarily US-owned manufacturers). In the case of Nissan's investment in the United Kingdom, Nissan responded to concerns about local content by pledging to increase the proportion of local content to 60 percent, and by subsequently raising it to over 80 percent.

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. A quarter of a century ago this concern was expressed by several European countries, who feared that FDI by US MNEs was threatening their national sovereignty. The same concerns are now surfacing in the United States with regard to European and Japanese FDI. The main fear seems to be that if foreigners own assets in the United States, they can somehow "hold the country to economic ransom." Twenty-five years ago when officials in the French government were making similar complaints about US investments in France, many US politicians dismissed the charge as silly. Now that the shoe is on the other foot, many US politicians no longer think the notion is silly. However, most economists dismiss such concerns as groundless and irrational. Political scientist Robert Reich recently spoke of such concerns as the product of outmoded thinking because they fail to account for the growing interdependence of the world economy.¹¹ In a world where firms from all advanced nations are increasingly investing in each other's markets, it is not possible for one country to hold another to "economic ransom" without hurting itself.