Order 1000433: In a world of high capital mobility, how do foreign direct investment (FDI) inflows affect the domestic politics and economics of developing countries?

When an investor is deciding in which country to allocate his resources there are several factors which are to be taken into account. FDI connotes large amounts of capital, for which investors must assess the political and economic situation of the developing country of choice before allocating their funds in a business. In Latin America the three greatest recipients of FDI are Brazil, Chile, and Colombia while in Africa it is South Africa, the Republic of Congo, and Mozambique. Investors take into account the resources at hand and other factors that would make their investment fruitful. For example, Brazil has a market of nearly 210 million inhabitants and is less vulnerable to international crises due to its diversified economy, while Colombia is rich in natural resources and has enjoyed greater political stabilization thanks to the disarmament procedures of the FARC. What is important to grasp from this is that developing countries are very attractive destinations for FDI as they hold promising rewards, but there is always a risk to every business venture. Bolivia and Venezuela have proven to be the perfect examples for FDI going wrong. Both countries promised fruitful returns as each held specific features that are very attractive for investors, but due to the decisions taken by their significant heads of state these nations now find themselves at a limbo, as they are now limited in regards to their market possibilities. Venezuela possesses large oil reserves, a large size of domestic market and further extensive natural resources, but due to its uncertain legal system which allowed infringements to property rights, foreign currency controls and increasing regulations investors no longer want to allocate FDI. The same goes for Bolivia which holds the world’s largest reserve of lithium. In short, FDI has proven to be very beneficial for some countries such as Brazil and South Africa, while Bolivia and Venezuela seem to have come out in disadvantage, but why?

FDI can cause both positive and negative effects on the political and economic spectrums of a nation. On one hand they are beneficial as they provide capital, technology, managerial expertise, global marketing networks, and employment to a developing society and therefore stimulate its growth. On the other hand, they may also provoke negative effects such as an ambiguous effect on the balance of payments, the crowding out of scarce local savings, the suppression of local competition, and in some cases refusal to transfer technology. Out of those various factors the most interesting one seems to be the effects produced by balance of payments due to the fact that these can be either extremely beneficial or catastrophic for a country. In the best case scenario, a positive effect of balance of payments will produce an inflow of capital, serve as a substitute for imports, and consequently cause an inflow of payments from export of goods and services. In the worst case scenario, after an inflow of capital a reciprocal outflow develops from the earnings of the FDI. Further, the FDI can lead towards an increment in imports of inputs and intermediate goods from abroad, transfer pricing and profit repatriation.

With this in mind, in which case would these situations arise, and further what could trigger these specific outcomes? At the end of the day, it all comes down to the person in charge and the way in which they are running the FDI. Either it being the elites or the government itself who negotiate the terms of a contract for FDI to take place, the success of the venture, and further the kind of effects it will produce, depend largely on the interests and goals of the host actors as they are the ones who will ultimately decide the route which will be taken. Through the expropriation of FDI several have been the governments of developing countries that have gained grand amounts of income to do as they please, and because they hold this kind of power host characters seem to hold leverage over MNCs. Due to the international nature of the contracts being made concerning FDI, MNCs have to abide by the local legal system and regulations which not only disarms the corporation from being able to apply international standards, but moreover provides the host government with leverage enough to determine the definition of property rights and their application within their national territory. What’s worse is that neither expropriation nor the standard of compensation for said action have been legally addressed by international law which provides further coercive power to the local government when it comes to deciding either to expropriate FDI or not to (Easton & Gersovitz, 1983; Thomas & Worrall, 1994). Moreover, in the long-run expropriated ventures managed by the host country tend to perform in a less efficient manner and require continuous subsidies to stay afloat (Megginson & Netter, 2001; minor, 1994). This means that after expropriating FDI a country’s government may benefit from the short term benefits such as the sudden inflow of capital, but on the long-run expropriation seems not to be advisable for the population as a whole. FDI connotes extremely positive results if managed correctly through friendly cooperation between the local government and the investors, but when nationalization takes place governments falter to take care of the venture therefore causing negative effects.

Taking into consideration the undesirability of expropriation due to its negative connotations, what are then the incentives of a head of state to conduct the expropriation of FDI? Depending on the type of government at hand, the political interests of the governing political party, and further the time horizon of the head of state’s mandate the reasons behind the action of expropriation of FDI in developing countries can be determined (Li, 2009). Despite a common belief that authoritarian regimes are more beneficial for MNCs due to better entry deals caused by the lack of popular pressure, the repression of labor unions, and overall lower-cost workforces, in reality democracies are indeed better options for MNC’s. This is due to a stable political environment which gives the nation credibility, and friendlier international agreements and relations which will foster a better future for FDI expansion (Jensen, 2003). Consequently, it can be assumed that authoritarian regimes are less advantageous for FDI in comparison to democracies due to the risks of political instability and expropriation.

At the end of the day, the real incentive for expropriation lies in the time horizon of the head of states’ mandate. In the long-run, FDI ventures which have been expropriated have demonstrated to perform in a less efficient manner in comparison to previous stages in which they were under the control of MNCs. Therefore, when a leader decides to expropriate it is usually for short-run benefits (Geddes, 1994). For example, if a president is going to step down from office soon he is more likely to expropriate FDI in order to provide his political party with means to win the next election. On the other hand, if a leader has a long horizon mandate, he is more likely to leave FDI alone as a way to guarantee political and economic stability due to the long-run benefits of said ventures. This phenomenon is better explained by Olson’s stationary bandit effect which says that authoritarian governments that have a tight grip on power want to stay in office for a long time and therefore will protect property rights of MNCs as a way to ensure future gains from their subjects (McGuire & Olson, 1996; Olson, 1993). In short, the incentives which will lead a head of state to expropriate or non-nationalize depend mostly on the political context of their nation and the time they have left in office.

With that said in order to determine the effects of FDI in developing countries it is now time to analyze the actual policies being taken by the governments considering their declared regime types, their historical and political backgrounds, and further the degree of corruption in their systems. First of all, many are the developing countries that claim to be democracies, yet they do not act in the best interest of their populations and further violate their constitutions frequently. Once again Bolivia and Venezuela are perfect examples as both have experienced situations in which their presidents have changed the constitutions and have been accused of manipulating election results. In other words, despite of being recognized as democracies several developing countries do not enjoy the credibility factor typically attributed to this type of regime due to their unpredictable practices making their governments more likely to expropriate FDI in comparison to real democracies.

Second, in order to better understand the incentives of leaders to expropriate FDI the historical and political context of their governments must be taken into account. For example, Venezuela was a country which received a great deal of FDI during the 90’s and was one of the world’s largest producers of oil until Hugo Chavez took office and decided to nationalize foreign oil companies. Due to a grudge held against the United States and foreign powers Venezuela limited any sort of international involvement in its economy which led to a downfall of the country over the following years. Bolivia experienced a similar case after Evo Morales took office in 2005. Based on an anti-American sentiment mixed with a grudge founded since the age of colonization the novel indigenous government limited its commerce with international personalities and led to a decrease in its market size and further a destabilization of its economy. These are clear examples which portray deeper motives and incentives for the expropriation of foreign companies in developing nations being greed and revenge which are elements present in several official remarks done by these heads of state. Moreover, the most important motive and cause for expropriation which has not been addressed is corruption. Developing countries have been plagued with corruption since they were granted independence and even today scandals are being discovered in which governments are directly linked. When expropriating FDI leaders do not just seek a better position for their political parties in the next election, but rather take their own personal interests into account.

Overall, FDI can be either extremely fruitful for developing countries or particularly detrimental. There are countless differences between developing nations that enjoy the benefits of FDI in comparison to others countries which do not benefit as much, but at the end it all sums up to the political approach adopted by the heads of state. Brazil and South Africa have experienced clear cases of corporate corruption just like Venezuela or Bolivia, but the decision to nationalize and adopt a protectionist stance towards the world market is the difference between a nation that strives to grow in comparison to one that deals with internal upheaval and growing poverty. FDI can bring opportunity, development and cash inflow, but through the expropriation of this asset problems surge due to the lack of proper management and human capital. Foreign direct investment is mostly advisable for economies that are willing to maintain friendly relationships with MNCs as they will be productive and fruitful whilst nations that decide to expropriate will face negative outcomes. In short, the source of FDI related problems in developing countries is not the presence of FDI itself, but rather the government’s decision to expropriate and adopt protectionist measures.

References

· Bolivia: Foreign investment. (n.d.). Retrieved April 17, 2017, from