Transcript Document

***POLITICAL ECONOMY***
THE POLITICAL ECONOMY OF FDI
Some people and/or countries regard FDI, or more generally, multinational
enterprises (MNEs) as a tool of imperialism (a radical view).
However, most have more pragmatic views on MNEs
The benefits and costs of FDI
(A) to host countries:
1. Benefits
2. Costs
3. Unclear
Example. Balance of payments???
Example. Environment?
Recall:
the impact of inward FDI on the host country’s balance of payments:
Construction, FDI’s exporting, $ from abroad (?)
FDI’s dividends, consulting fees, etc (?)
(B) to home countries:
1. Benefits: efficient allocation of resources
2. Costs
3. Uncertain
Example. Balance of payments (same as above)
Example. Environment?
Implications for IB:
Where should you build your overseas factory?
Your negotiation with the host country government for FDI may be needed
-Relatively little problem exists for most developed countries. But some (like
Canada) do have foreign investment review mechanisms, particularly, for
certain industries (why?)
-Developing countries usually have some forms of restrictions on FDI
(why?)
-Important to recognize what gives you and the host government the
bargaining power (we’ll discuss this shortly)
- The higher your bargaining power is relative to the bargaining power of
the host government, the more of what you want you will get in your FDI
POLITICAL ECONOMY OF FDI (Con’d):
The Bargaining Power and FDI
The outcomes of the negotiation between you (MNEs) and the host
government (h.g.) about your FDI in developing countries reflected in:
(1) tax, foreign exchange and other financial concessions by the h.g.;
(2) legal arrangements;
(3) the rights to name board members; and
(4) local (or your) ownership share in your FDI (subsidiary). (Related to (3).)
Example. Tax issue involving Amazon.com and political economy
The Japan-U.S. bilateral tax treaty allows U.S. firms to operate in Japan
without paying Japanese taxes under the following conditions:
“U.S. companies that engage in business in Japan without "permanent establishment"
such as branch offices from having to file a tax return or pay taxes in Japan.”
Because Japan’s corporate income tax rate is higher than US.’s, U.S. firms have every
incentive to use this form of FDI where possible.
Amazon.com is one of them. Their business in Japan has been highly successful and
profitable. They keep their inventories in a number of large warehouses in Japan, from
which their subsidiaries operate logistics for Amazon International.
Japanese tax authorities decided that this form of Amazon.com’s operation
in Japan is a branch office operation and collected from them US$119
million as back taxes plus penalty.
The Tokyo Regional Taxation Bureau has determined that Amazon.com’s two Japanese wholly
owned subsidiaries have in effect acted as branch offices of the affiliate, Amazon.com
International Sales Inc. (The two subsidiaries, Amazon Japan Logistics K.K. and Amazon Japan
K.K., are commissioned to carry out merchandise distribution and other functions. Amazon.com
International Sales concluded direct contracts with its customers in Japan and received payments
for goods, the sources said.) The tax bureau reportedly told Amazon.com International Sales that
it should have declared to Japanese tax authorities a substantial amount of the income gained
through transactions in Japan. Amazon.com disclosed in its annual report for the 2008 business
year that it has been ordered by Japanese tax authorities to pay US$119 million as the back taxes
plus penalty for an amount equivalent to ¥14 billion.
Amazon.com International Sales is responsible for operations outside the United States. The
company has booked sales posted in Japan as those of the Seattle-based company while paying
relevant taxes only in the U.S. But the tax bureau found that employees of Amazon Japan
Logistics have received instructions from the U.S. side through e-mails at its distribution center
in Ichikawa, Chiba Prefecture, while approval by the U.S. side was required whenever the
center's administrators assigned its employees to new posts, the sources said, indicating it acted
as a branch.
Amazon filed objections about this judgment, and Japanese and U.S. governments are negotiating
this issue. However, other countries where Amazon operates in a similar way may follow Japan’s
suit.
The most important outcome of the negotiation between the host government and
you is:
Local (and hence your) ownership share in the foreign operation
you own 100 %, local share 0%
80%, local share (who?) 20%
50%, local share (who?) 50%
20%, local share (who?) 80%
.....………………………...........................................
Many governments in developing countries consider local ownership as an
important goal when they negotiate with foreign investors. The ownership issue
also arises sometimes in developed countries.
This may be due to their political motivations; investment regulations emphasize
joint venture requirements; worries about foreign control of key industries, etc.
WHY?
Example. Canadian limits on foreign ownership in airlines: 33%; telephone
operators (AT&T Canada-33%); .....
Many (but not all) MNEs also view ownership share in FDI very important
Examples.
-Why did IBM and Coca-Cola insist on fully owned subsidiaries for their key FDI
operations in India?
-Recently, Russia required Shell and other MNEs to give up their owenership in JVs to
explore oil and gas in Sakhalin Island; Kazafstan also reduced MNEs’ ownership in their
JVs in the oil industry.
Many governments (and also MNEs) are unwilling to trade ownership for other
kinds of benefits (particularly in resource sectors).
Your share and local share in your FDI are determined by your relative
bargaining power vis-a-vis the host government’s bargaining power.
What are the sources of bargaining power ?
Your ownership in an FDI operation in a developing country often determined by
negotiation with the host government
Such negotiations may also be necessary for FDI in sensitive industries in developed countries (e.g.
resources, defence, regulated industries,…)
Your bargaining power is higher if you can offer what the other party (the
host government) wants.
Of course, higher bargaining power --- > less trouble on FDI (e.g.
confiscation)
Sources of your bargaining power
1. Technology: U.S. operations in Latin America:
R&D / sales (%)
0 -. 75
.75 - 2.5
2.5 - 5.0
5% +
%ownership
88%
86
89
99
2. Product differentiation (p.d.)
Examples. Food, beverages, ball-point pens,.. Generally low-tech products.
Heavy multinational advertisers do not usually want to share marketing
policy
U.S. operations in Latin America
Adv / sales (%)
%ownership
0-1%
85
1-7
89
7% +
98
3. Market access
%output transferred
%ownership
within the parent system
0 - 10 %
80
10- 50
91
59- 100
96
%exported
0 - 10
88
10- 50
92
50- 100
98
Note: control over market access is a particularly effective deterrent to
expropriation
4. Competition weakens your bargaining power
# of parent firms competing in
3-digit SIC industry
%ownership
1
95
2
90
3-5
84
6+
83
Depending on the industry and the host government environment, one or
more of these factors provide bargaining power in your negotiation with the
host government and/or local partners.
Alternative Dissolution of Joint Ventures (A power game between the JV parents)
Additional examples: alternative dissolution of M&A and strategic alliances
Daimler and Chrysler (Daimler acquired Chrysler in a friendly M&A. Later split.)
Suspected reason: differences in country-specific and corporate culture . Fiat now
owns Chrysler.
Daimler and Mitsubishi Motor Corporation (Daimler acquired controlling share /
ownership of MMC (friendly M&A). Later Daimler sold back passenger car
business to MMC. Daimler still controls the former truck division of MMC
(Mitsubishi Fuso brand).)
Suspected reason: MMC’s non-disclosure of certain corporate information (related
to recallable car defects) in M&A negotiations.
VW and Suzuki Motor Corporation (In a friendly agreement, VW acquired
19.9% of Suzuki shares and Suzuki also acquired a small piece of VW, to exchange
technology related to environmentally friendly car designs, etc. Suzuki went ahead
with procuring diesel engines from Fiat without any consulting with VW,
infuriating VW. Suzuki and Fiat had prior business relationships. Suzuki argues
their relationship with VW to be an equal one, blaming VW’s increasing
interference with Suzuki’s management. Suzuki asked VW to sell back their Suzuki
shares to Suzuki immediately, and VW refused. The saga goes on.