Transcript Trading Spaces: The Political Economy of Foreign Direct Investment

Trading Spaces:
The Political Economy of Foreign
Direct Investment Regulation
Sonal S. Pandya
Department of Government
Harvard University
FDI Central to International
Economy
• Single largest source of global capital
flows
• Generates 20% of world trade flows
• Promotes economic development
Research Question
Why do countries regulate foreign direct
investment?
Restrictions Vary By Industry
Industry-Level Foreign Ownership Restrictions
25 Latin American Countries, 1997-2000
Two-digit Industry Categories
64 Post and telecommunications
92 Recreational, cultural and sporting activities
40 Electricity, gas, steam and hot water supply
66 Insurance and pension funding
12 Mining of uranium and thorium ores
62 Air transport
05 Fishing, operation of fish hatcheries and fish farms
11 Extraction of crude petroleum and natural gas
60 Land transport; transport via pipelines
10 Mining of coal and lignite; extraction of peat
# Restricting
Countries
10
9
8
8
7
7
6
6
6
5
Restrictions on Foreign Direct Investment by Region and Decade
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1963-1969
1970-1979
1980-1989
Asia
Latin America
1990-2000
Restrictions on Foreign Direct Investment in Latin America by Industry and Decade
100%
90%
Percent of Two-Digit ISIC Industries Restricted
80%
70%
60%
50%
40%
30%
20%
10%
0%
1963-1969
1970-1979
Primary Industries
Manufacturing Industries
1980-1989
Services
Horizontal Restrictions
1990-2000
Existing Explanations Insufficient
• Nationalism can’t account of multiple
dimensions of variation
• Scholarly literature makes assumptions re:
governments preferences for FDI
No Microfoundations
Political Economy Approach
Identifies Sources of Variation
• FDI inflows redistribute income
• Political cleavages between winners and
losers
• Politicians negotiate tradeoffs
Vertical FDI
FDI Inflow
Home Country
Host Country
Politics of Vertical FDI
• Vertical FDI’s Economic Effect
Increases labor demand
• Political cleavage
Labor vs. Capital
Local wages & production costs
increase
• Salient Political Institution
Partisanship
Horizontal FDI
FDI Inflow
Finished Product
Home Country
Host Country
Politics of Horizontal FDI
• Horizontal FDI’s Economic Effect
Increases market competition
• Political cleavage
Producers vs. Consumers
Local firms’ profit & prices decrease
• Salient Political Institution
Electoral Competition
Alternate Explanation:
Nationalism
• FDI increases foreign ownership
Foreign ownership threatens national
identity
Hypotheses
• Left governments are less likely to restrict
vertical FDI
• Electoral competition reduces the
probability of restrictions on horizontal FDI
• Nationalist governments more likely to
restrict FDI
Measuring FDI Regulation
• Foreign ownership restriction
1 = banned, only minority share allowed
0 = no limit
• Data coded from US Commercial Guides
119 countries, 58 industries, 1990s (pooled)
Approx. 30% of country-industries restricted
Measuring Propensity Vertical FDI
Restrictions
• Interaction of Host Labor Supply and
Industry Labor Demand
Data:
Average Schooling
Industry per worker value-added for USbased multinational firms
Partisanship
Support for Vertical FDI at
Low Skill Levels
Logit Model Estimates
Left Party x
(Low Skill)
Right Party x
(Low Skill)
-2.71 #
(1.64)
0.0362
(0.58)
# = significant at .1 level
Measuring Industry’s Propensity to
Receive Horizontal FDI Restriction
• Incentives to enter market via horizontal
FDI
Data
Host country GDP
Gravity model estimates of trade barriers
Degree electoral competition
Expected Probability of Foreign Ownership
Restrictions at Varying Levels of Democracy
Level of Democracy
No executive/legislature
Unelected executive/legislature
Elected, one candidate
One party, multiple candidates
Multiple parties legal but only
one won seats
Multiple parties compete and won
seats but one party holds more
than 75% of seats
Largest party received less than
75% of seats
E (Foreign Ownership Restriction
| Level of Democracy)
1
1
0.99
0.998
0.985
0.89
0.50
Nationalist Governments Less
Likely to Restrict
Shift to executive from nationalist party
decreases expected probability of ownership
restriction by 24 percentage points*.
*standard deviation = .08
Summary of Results
• Left parties less likely to restrict FDI in
lower skilled industries
• Weak democracies use FDI restrictions as
substitutes for trade restrictions; in
stronger democracies restrictions less
sensitive to market entry barriers
• Governments led by nationalist executives
less likely to restrict FDI