Encouraging Outward FDI

Many investor nations now have government-backed insurance programs to cover

major types of foreign investment risk. The types of risks insurable through these programs

include expropriation (nationalization), war losses, and the inability to transfer

profits home. Such programs are particularly useful in encouraging firms to undertake

investments in politically unstable countries.j" In addition, several advanced countries

also have special funds or banks that make government loans to firms wishing to invest

in developing countries. As a further incentive to encourage domestic firms to undertake

FDI, many countries have eliminated double taxation offoreign income (i.e.,

taxation of income in both the host country and the home country). Last, and perhaps

most significant, a number of investor countries (including the United States) h;;tve

used their political influence to persuade host countries to relax their restrictions on

inbound FDL For example, in response to direct U.S. pressure,Japan relaxed many

of its formal restrictions on inward FDI in the 1980s. Now, in response to further U.S.

pressure,Japan moved toward relaxing its informal barriers to inward FDL One beneficiary

of this trend has been Toys "R" Us, which, after five years of intensive lobbying

by company and U.S. government officials, opened its first retail stores inJapan

in December 1991. By 2000, Toys "R" Us had more than 150 stores inJapan, and its

Japanese operation, in which the company retained a controlling stake, had a listing

on the Japanese stock exchange.

Restricting Outward FDI

Virtually all investor countries, including the United States, have exercised some control

over outward FDI from time to time. One common policy has been to limit capital

outflows out of concern for the country's balance of payments. From the early

1960s until 1979, for example, Great Britain had exchange-control regulations that

limited the amount of capital a firm could take out of the country. Although the main

ntentof such policies was to improve the British balance of payments, an important

secondary intent was to make it more difficult for British firms to undertake FDI.

In addition, countries have occasionally manipulated tax rules to try to encourage

their firms to invest at home. The objective behind such policies is to create jobs at

home rather than in other nations. At one time these policies were also adopted by

Great Britain. The British advanced corporation tax system taxed British companies'

foreign earnings at a higher rate than their domestic earnings. This tax code created

an incentive for British companies to invest at home.

Finally, countries sometimes prohibit firms from investing in certain countries for

political reasons. Such restrictions can be formal or informal. For example, formal

rules prohibited U.S. firms from investing in countries such as Cuba, Libya, and Iran,

whose political ideology and actions are judged to be contrary to U.S. interests. Similarly,

during the 1980s, informal pressure was applied to dissuade U.S. firms from investing

in South Africa. In this case, the objective was to pressure South Africa to

change its apartheid laws, which occurred during the early 1990s. Thus, this policy

was successful.

HOST-COUNTRY POLICIES

Host countries adopt policies designed both to restrict and to encourage inward FDI.

As noted earlier in this chapter, political ideology has determined the type and scope

of these policies in the past. In the last decade of the 20th century, many countries

moved quickly away from adhering to some version of the radical stance and prohibiting

much FDI and toward a combination of free market objectives and pragmatic

nationalism.

Encouraging Inward FDI

It is .infTPa".i.r.>gJy commas: for govemments to offer incentives to foreign firms to invest

in their countries. Such incentives take many forms, but the most common are

tax concessions, low-interest loans, and grants or subsidies. Incentives are motivated

by a desire to gain from the resource-transfer and employment effects of FDI. They

are also motivated by a desire to capture FDI away from other potential host countries.

For example, in the mid-1990s the governments of Great Britain and France

competed with each other on the incentives they offered Toyota to invest in their respective

countries. In the United States, state governments often compete with each

other to attract FDI. For example, Kentucky offered Toyota an incentive package

worth $112 million to persuade it to build its U.S. automobile assembly plants there.

The package included tax breaks, new state spending on infrastructure, and lowinterest

loans.t"

Restricting Inward FDI

Host governments use a wide range of controls to restrict FDI in one way or another.

The two most common are ownership restraints and performance rf'-9JJir.t'.we.>;ltu~.

OwnershIp restraints can take several forms. In some countries, foreign companies are

excluded from specific fields. For example, they are excluded from tobacco and mining

in Sweden and from the development of certain natural resources in Brazil, Finland,

and Morocco. In other industries, foreign ownership may be permitted although

a significant proportion of the equity of the subsidiary must be owned by local investors.

For example, foreign ownership is restricted to 25 percent or less of an airline

in the United States.

Foreign firms are often excluded from certain sectors on the grounds of national security

or competition. Particularly in less developed countries, the belief seems to be

that local firms might not be able to develop unless foreign competition is restricted

by a combination of import tariffs and FDI controls. This is really a variant of the infant

industry argument discussed in Chapter 5.

Also, ownership restraints seem to be based on a belief that local owners can help

to maximize the resource-transfer and employment benefits ofFDI for the host country.

Until the early 1980s, theJapanese government prohibited most FDI but allowed

joint ventures betweenJapanese firms and foreign MNEs if the MNE had a valuable

technology. The Japanese government clearly believed such an arrangement would

speed up the subsequent diffusion of the MNE's valuable technology throughout the

Japanese economy.

Performance requirements can also take several forms. Performance requirements

are controls over the behavior of the MNE's local subsidiary. The most common performance

requirements are related to local content, exports, technology transfer, and

local participation in top management. As with certain ownership restrictions, the

logic underlying performance requirements is that such rules help to maximize the

benefits and minimize the costs of FDI for the host country. Virtually all countries employ

some form of performance requirements when it suits their objectives. However,

performance requirements tend to be more common in less developed countries than

in advanced industrialized nations. For example, one study found that some 30 percent

of the affiliates of U.S. MNEs in less developed countries were subject to performance

requirements, while only 6 percent of the affiliates in advanced countries were

faced with such requirementsY