trading spaces: the political economy of foreign direct investment regulation sonal s. pandya...
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Trading Spaces: The Political Economy of Foreign
Direct Investment Regulation Sonal S. Pandya
Department of Government
Harvard University
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FDI Central to International Economy
• Single largest source of global capital flows
• Generates 20% of world trade flows
• Promotes economic development
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Research Question
Why do countries regulate foreign direct investment?
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Restrictions Vary By Industry
Industry-Level Foreign Ownership Restrictions25 Latin American Countries, 1997-2000
Two-digit Industry Categories # Restricting Countries
64 Post and telecommunications 1092 Recreational, cultural and sporting activities 940 Electricity, gas, steam and hot water supply 866 Insurance and pension funding 812 Mining of uranium and thorium ores 762 Air transport 705 Fishing, operation of fish hatcheries and fish farms 611 Extraction of crude petroleum and natural gas 660 Land transport; transport via pipelines 610 Mining of coal and lignite; extraction of peat 5
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Restrictions on Foreign Direct Investment by Region and Decade
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1963-1969 1970-1979 1980-1989 1990-2000
Asia Latin America
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Restrictions on Foreign Direct Investment in Latin America by Industry and Decade
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1963-1969 1970-1979 1980-1989 1990-2000
Perc
ent o
f Tw
o-D
igit
ISIC
Ind
ustr
ies
Res
tric
ted
Primary Industries Manufacturing Industries Services Horizontal Restrictions
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Existing Explanations Insufficient
• Nationalism can’t account of multiple dimensions of variation
• Scholarly literature makes assumptions re: governments preferences for FDI
No Microfoundations
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Political Economy Approach Identifies Sources of Variation
• FDI inflows redistribute income
• Political cleavages between winners and losers
• Politicians negotiate tradeoffs
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Vertical FDI
Home Country Host Country
FDI Inflow
Finished Product
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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
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Horizontal FDI
Home Country Host Country
FDI Inflow
Finished Product
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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
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Alternate Explanation: Nationalism
• FDI increases foreign ownership
Foreign ownership threatens national identity
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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
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Measuring FDI Regulation
• Foreign ownership restriction1 = 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
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Measuring Propensity Vertical FDI Restrictions
• Interaction of Host Labor Supply and Industry Labor Demand
Data:
Average Schooling
Industry per worker value-added for US-based multinational firms
Partisanship
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Left Party x(Low Skill)
-2.71 # (1.64)
Right Party x(Low Skill)
0.0362 (0.58)
Support for Vertical FDI at Low Skill Levels
# = significant at .1 level
Logit Model Estimates
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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
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Expected Probability of Foreign Ownership Restrictions at Varying Levels of Democracy Level of Democracy E (Foreign Ownership Restriction
| Level of Democracy)
No executive/legislature 1
Unelected executive/legislature 1
Elected, one candidate 0.99
One party, multiple candidates 0.998
Multiple parties legal but only one won seats
0.985
Multiple parties compete and won seats but one party holds more than 75% of seats
0.89
Largest party received less than 75% of seats
0.50
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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
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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