Fall - 2012 Economic1

Published on November 26th, 2012

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Economic Nationalism and Foreign Direct Investment – A Great Risk for Investors

By Tor G. Jakobsen, NTNU

In an increasingly globalized world, foreign direct investment (FDI) is becoming a driving force of the economy. But there are great risks involved for the investors, for example the lure of expropriation or consumer boycotts. It is shown that economic nationalism among the public leads to a decrease in FDI-flow.

Investing capital in developing countries is often associated with an element of political risk, as was illustrated in season two of the popular television soap opera Dallas. The scheming main character of the show, J.R. Ewing, made a highly profitable investment in some Asian oil leases. The country where the oil wells were located (the name of the country was never mentioned in the series) experienced a coup, and the subsequent nationalization of the oil wells, making J.R.’s investments worthless.

This provided the viewers with an example of the connection between high profits and high risks, and also the danger of economic nationalism with regard to foreign investment. Luckily for J.R., as the cunning character he was, he had learnt about the coup before the media had picked it up, and managed to sell his oil leases before it was too late. Yet, a minus was that he lost a lot of business credibility as he sold the leases to some of his closest associates, with the result being that their fortunes were wiped out.

Dallas is of course fiction, yet, J.R.’s hardships with Asian nationalists is illustrative of events taking place concerning foreign firms in many developing countries. On May 1, 2006 President Evo Morales announced plans to put Bolivia’s gas industry under state control. Foreign companies were given six months to renegotiate contracts in order to give up majority control over their Bolivian interests.

 

What is Foreign Direct Investment?

The World Bank states that foreign direct investment presupposes an enduring management interest of 10 percent or more of voting stock in a company operating in another country than that of the investor. FDI is thus the net inflows of investments from such companies.

Measures of democracy are commonly employed in the literature on political risk and foreign direct investment. The role of government as far as Multinational Companies are concerned is to act as a provider of infrastructure and guardian of laws and contracts, which democracies are assumed to be better at than other forms of government. Governments who cannot arrange for these requirements, are likely to receive less FDI than those governments who can. Sound institutions are vital to attracting foreign investors, as these are necessary to guarantee the rule of law. Economic development is presupposed to have a strong positive impact on FDI. The more developed a country is, the more FDI-inflow it will receive.

 

Economic Nationalism

The question of whether economic nationalism matter on foreign direct investment-flow (FDI) is of importance to both multinational companies wishing to establish, and to the potential host countries. In a globalized world, FDI is increasing its position as the main engine of the economy.

The dominating view in the literature is that economic nationalism is bad for FDI-flow. According to Professor Robert M. Norris, public opinion in foreign countries is believed to influence the results of a company operating outside its home, regardless of its organizational type.

This is perhaps most true for developing countries (LDCs). The independence of many nations in the post-1960 period was followed by sundry expropriations and nationalizations. ). If the population of a given country holds grievances, expropriation or nationalization is a low cost solution for appeasing the general public. In such a case, nationalization could be used as a tool for strengthening the regime’s domestic legitimacy.

The fear of a regime’s propensity towards acting along anti-foreign opinions in the public should act as a deterrent to foreign direct investment. The examples of public opinion materializing in policy action are numerous. In Latin Americaseveral countries have incorporated what is known as the Calvo doctrine into their constitutions. This foreign policy doctrine asserts that the right of jurisdiction concerning international investment disputes lies with the country in which the investment is made.

Causal chain, from economic nationalism to a decrease in FDI-flow.

The mechanism shown in the figure is exemplified by the events that took place in Colombia in 1970, when the government, accommodating public opinion, forced foreign companies to sell out the majority of their stock to local investors. The negative attitude against multinational companies (MNCs) has from the 1970s spread from Latin America throughout the Third World, leading many governments to enforce less investor-friendly policies.

Of course, economic nationalism can also have a more direct effect, not necessarily through the intervening link of the regime. Negative sentiments among the public can have a direct impact, through decreasing sales, or difficulties with regard to the work force.

Such factors will lead to an increased chance of an already established MNC to pull out of the country in question, thus leading to lower total FDI-flow. Yet, this proposed causal chain, I hold, is not as prominent as the one shown in the figure. This is because government action (which is sprung out from public opinion) is easier to interpret, as it is constituted in laws and regulations. It is more difficult for a MNC to get a clear picture of the exact public sentiments.

To summarize the causal chain, economic nationalism among the public will be taken into account by the rulers, who tends to cater to the preferences of the electorate. This leads to an increased risk of expropriation and nationalization of foreign assets. The threat of confiscation would accordingly also be perceived as political risk and cause foreign investors to be cautious about investing in the country in question. In addition we also have the possible direct effects of economic nationalism through boycotts or decreasing profits for the MNCs, leading to less investment.

 

The Findings

By employing advanced regression modeling for time-series cross-section data, an analysis done by Jo Jakobsen and Tor G. Jakobsen including 42 countries shows there is a strong negative impact of individual level economic nationalism on the flow of FDI. Economic nationalism among the public both directly and indirectly, through the intervening mechanisms of the executive and legislative powers, have profound negative effects on FDI.

This implies that sentiments among the public is of importance (both directly and indirectly) to the MNCs.

 

Conclusion

The findings imply that the governments should not waiver to the day to day popular opinions, but rather follow a long term political strategy to promote trade and liberalization. Yet, some responsibility lies with the MNCs themselves. Foreign investors can utilize strategies to improve their image. For example, the organizational ecology school within business strategy argues that an organizational form that is not accepted in a host country will not survive. MNCs should therefore use a more accepted organizational form to achieve legitimacy, and thus survive in the new environment. Another solution is to make efforts to improve their reputation. Examples of this are companies that build roads and schools in their respective host countries to achieve acceptance with the local populace.

 

Further reading:

 

Gilpin, Robert (1987). The Political Economy of International Relations. Princeton, NJ: Princeton University Press.

Jakobsen, Jo (2007). Political Risk for Multinational Companies: Sources and Effects. Thesis for the degree philosophiae doctor,Trondheim: NTNU.

Jakobsen, Jo & Tor G. Jakobsen (2011) “Economic Nationalism and FDI: The Impact of Public Opinion on Foreign Direct Investment in Emerging Markets, 1990–2005” Society and Business Review, 6(1): 61–76.

Li, Quan and Adam Resnick (2003) “Reversal of Fortunes: Democratic Institutions and Foreign Direct Investment Inflows to Developing Countries” International Organization, 57 (1): 175–211.

Norris, Robert M. (1971) “Success Depends On Public Acceptance Abroad” Public Relations Quarterly, 16 (1): 9–11.

 

 

*cover photo by Richard Masoner, photo of burnt out cars by Alan Stanton

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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