The political economy of foreign direct investment and sourcing
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The Political Economy of Foreign Direct Investment and Sourcing. 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

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The Political Economy of Foreign Direct Investment and Sourcing

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The Political Economy of Foreign Direct Investmentand Sourcing

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!

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…

Nike employees


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

Political Ideology and FDI







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

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

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

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


But who can predict which FDI is in national interest?

Regulations open opportunity for favoritism

Pragmatic Nationalism

Many of the most successful developing countries – past and present – followed a pragmatic nationalistic stance


South Korea


Economists note that Hong Kong, which followed the free marketapproach, was even more successful

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

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

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

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

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

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

Info on slides below here is not required

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

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

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

Gross Capital Fixed Formation

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

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