Effects of FDI

Governments prefer to run a current account surplus, or export more than they import, otherwise, the
country is paying out more for the exports than it’s bringing in on its imports. Does this situation sound
familiar? The U.S. has had a current account deficit for years, and is financing it by selling off U.S. assets
to foreigners.

FDI can have a positive effect on a country’s balance of payments because it limits imports. So, instead
of buying that Nissan directly from Japan, we’re now making it in Tennessee!

19. How does FDI affect competition and economic growth? If FDI is in the form of greenfield
investment, competition will increase in a market. This should drive down prices and benefit
consumers.

More competition also promotes increased productivity, innovation, and then, economic growth. We’ve
seen huge improvements in world telecommunications for example, since the 1997 WTO agreement to
liberalize the industry.

20. But, what about the costs of FDI?

There are three main costs of inward FDI. First, the negative effects on competition within the host
country. Second, the negative effects on the balance of payments. And third, the loss of national
sovereignty and autonomy that may occur.

21. Host governments, particularly those of developing countries, worry that the subsidies of foreign
MNE’s might end up having greater economic power than indigenous competitors. So, for example, if
an MNE supports its subsidiary while it becomes established in the host market, it might be stronger
than an indigenous company, and could drive the local company out of business.

22. When it comes to the balance of payments, host countries worry that along with the capital inflows
that come will the FDI, will be the capital outflows that occur when the subsidiary repatriates profits to
the parent company. Some countries actually limit the amount of profits that can be repatriated to limit
the negative effects of this.

Host countries are also concerned that some subsidiaries import a substantial number of their inputs.
Of course, these imports will show up in the current account of the balance of payments. Japanese
automakers, for example, import from Japan, many of the components they use in their American
operations. The companies have responded to criticism about this by pledging to buy more inputs
locally.

23. Sometimes host governments worry that they may lose some economic independence as a result of
FDI. They worry that since foreign companies have no particular commitment to the host country, they
won’t really worry about the consequences of their decisions on the host country. However, Robert
Reich, a former member of the Clinton cabinet, notes that this is really outdated thinking. In today’s
interdependent economy, no company maintains strong loyalty to any country.

24. What about the home country? Are there any benefits from outward FDI? Yes, FDI can help the
home country in several ways. It has a positive effect on the capital account because of the inward flow
of foreign earnings, there are positive employment effects that come from the foreign subsidiary
imports. Remember that Nissan imports a lot of inputs from Japan creating jobs there. There is also the
potential to learn valuable skills in the host nation that can then be transferred back to the home
country.

25. What about the home country? Are there any benefits from outward FDI? Yes, FDI can help the
home country in several ways. It has a positive effect on the capital account because of the inward flow
of foreign earnings, there are positive employment effects that come from the foreign subsidiary
imports. Remember that Nissan imports a lot of inputs from Japan creating jobs there. There is also the
potential to learn valuable skills in the host nation that can then be transferred back to the home
country.

26. A key reason that firms may resist FDI is because of the risk involved. To minimize this concern,
many countries have government-backed programs that cover the major forms of risk like the risk of
expropriation, war losses, or the inability to repatriate profits. Some countries have also developed
special loan programs for companies investing in developing countries, created tax incentives, and
encouraged host nations to relax their restrictions on inward FDI.

27. To discourage outward FDI, countries regulate the amount of capital that can be taken out of a
country, use tax incentives to keep investments at home, and actually forbid investments in certain
countries like the U.S. has done for companies trying to invest in Cuba and Iran.

28. Host countries can also restrict or encourage FDI. Recall that we’ve moved away from the
radical stance that discouraged FDI in general and towards a more free market approach, and pragmatic
nationalism.

To encourage inward FDI, host countries usually offer incentives for investment like tax breaks, low
interest loans, or subsidies. Why would countries offer these benefits to foreign firms? Because they
want to gain the benefits of FDI that we talked about earlier! Kentucky for example, offered a $112
million package to Toyota to get it to build its U.S. plants in the state!

29. Host countries can also restrict or encourage FDI. Recall that we’ve moved away from the
radical stance that discouraged FDI in general and towards a more free market approach, and pragmatic
nationalism.

To encourage inward FDI, host countries usually offer incentives for investment like tax breaks, low
interest loans, or subsidies. Why would countries offer these benefits to foreign firms? Because they
want to gain the benefits of FDI that we talked about earlier! Kentucky for example, offered a $112
million package to Toyota to get it to build its U.S. plants in the state!