The Political Economy of Foreign Direct Investment and Sourcing

1. The Political Economy of Foreign Direct Investmentand Sourcing

2. We all play roles of participants in ‘town meeting’ to discuss global sourcing We’re in Tower Hall or Washington Square Hall auditorium with Senior executives of Nike Activists critical of Nike Topic: “Should Nike change its approach to sourcing?” Big debate next week!

3. You decide what role you want to play in the debate Discuss what questions you will ask the debaters from the perspective of your role Many of the groups have members from countries that do manufacturing for Nike Be sure to ask whether they have personal opinions on the questions Today in groups…

4. Nike employees Stockholders U.S. labor leaders (or ordinary union members) Human rights activists (maybe rivals of the debaters) Asian workers flown to the U.S. by human rights activists Economic development officials of Asian countries Ordinary concerned citizens In this role, it’s fine to just be yourself Your group should pick one or two of the following roles

5. Political Ideology and FDI Radical View Pragmatic Nationalism Free Market

6. Marxist view: MNE’s exploit less-developed host countries Extract profits Give nothing of value in exchange Instrument of domination, not development Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology The Radical View

7. By the end of the 1980s radical view was in retreat Collapse of communism Bad economic performance of countries that embraced the radical view Strong economic performance of some countries that embraced capitalism rather than the radical view The Radical View

8. Nations specialize in goods and services that they can produce most efficiently Resource transfers benefit and strengthen the host country Pro-investment changes in laws and growth of bilateral agreements attest to strength of free market view But all countries impose some restrictions on FDI The Free Market View

9. FDI has benefits and costs Allow FDI if benefits outweigh costs Block FDI that harms indigenous industry Encourage FDI that is in national interest Tax breaks Subsidies But who can predict which FDI is in national interest? Regulations open opportunity for favoritism Pragmatic Nationalism

10. Many of the most successful developing countries – past and present – followed a pragmatic nationalistic stance Japan South Korea China Economists note that Hong Kong, which followed the free marketapproach, was even more successful

11. They have an association, the Organization for Economic Cooperation and Development that requires members to open their markets to foreign direct investment The richest countries all practice an almost-free-market approach

12. Much of today’s sourcing involves FDI from countries like Korea to nations where costs are still low Korea, Taiwan benefited from low-wage contracting in 1960s, 70s, and 80s Will today’s exporters benefit if the entrepreneurship comes from other nations? FDI from newly developed to poorer developing countries

17. Four main benefits of FDI for a host country Resource-transfer effect Employment effect Balance-of-Payments effect Effect on competition and economic growth In a free market view Many economists argue that the benefits of FDI so outweigh the costs associated with pragmatic nationalism that it is misguided The best policy would be for countries to forgo all intervention in an MNE’s investment decisions The Benefits of FDI to Host Countries

18. Can drive out local competitors or prevent their development Profits brought home ‘hurt’ (debit) a host’s capital account Parts imported for assembly hurt trade balance Can affect sovereignty and national defense Costs of FDI to the Home Country

23. Horizontal Direct Investment FDI in the same industry abroad as company operates at home FDI is expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise FDI is risky because of the problems associated with doing business in another culture where the rules of the game may be different “Horizontal” FDI

24. Transportation costs for a product are high Market Imperfections (Internalization Theory) Impediments to the free flow of products between nations Impediments to the sale of know-how Follow the lead of a competitor - strategic rivalry Product Life Cycle - however, does not explain when it is profitable to invest abroad Location specific advantages (natural resources) “Horizontal” FDI – When

28. Info on slides below here is not required

29. Vertical FDI takes two forms Backward vertical FDI is an investment in an industry abroad that provides inputs for a firm’s domestic production processes Forward vertical FDI occurs when an industry abroad sells the outputs of a firm’s domestic production processes, this is less common than backward vertical FDI Vertical FDI

30. One explanation for firm’s choice of vertical FDI is that by using vertical backward integration, a firm can gain control over the source of raw materials This would allow the firm to raise entry barriers and shut new competitors out of an industry Another explanation of vertical FDI is that firms use this strategy to circumvent the barriers established by firms already doing business in a country Strategic Behavior

31. The market imperfections approach offers two explanations for vertical FDI There are impediments to the sale of know-how through the market mechanism Investments in specialized assets expose the investing firm to hazards that can be reduced only through vertical FDI Market Imperfections

32. Gross Capital Fixed Formation

33. Market imperfections are factors that inhibit markets from working perfectly In the international business literature, the marketing imperfection approach to FDI is typically referred to as internalization theory With regard to horizontal FDI, market imperfections arise in two circumstances: When there are impediments to the free flow of products between nations which decrease the profitability of exporting relative to FDI and licensing When there are impediments to the sale of know-how which increase the profitability of FDI relative to licensing Market Imperfections