John Harvey and John Milios, (Entry in The Encyclopedia of Political Economy, edited by Philip O'Hara, London: Routledge, 1999).
FDI denotes export of productive non-loan capital from one country to another. It includes, therefore, capital exports for the establishment of subsidiary or joint venture companies, for company merges, etc. and it is related to the formation of TRANSNATIONAL CORPORATIONS. FDI is usually identified by ownership of at least 10% of the equity in an enterprise, and it covers claims that are intended to remain outstanding for more than one year. Loans between an associated company or subsidiary and mother company are in most cases considered by international statistics as FDI. FDI constitutes one of the major components in the capital accounts of the Balance of Payments.
Though FDI attained a significant role in the international economy in the first decade of the 2Oth century ,the real boom took place after World War II. From that point and up to the 1980's, the major FDI exporting country was the USA (which took the lead from the traditional pre-War FDI exporter, the UK). With the exception of these two countries and Japan (which had restrictions on inward FDI), the other important capital exporting countries (Germany, the Netherlands, France, Canada), were, at least until the mid 1970s, net capital importers, as inward FDI exceeded the value outward FDI. In the 1990s, Japan became the world's major FDI exporter, while the UK turned into a net FDI importer.
Each of the major heterodox perspectives has contributed something useful to the study of FDI, as has orthodox economics. Beginning with the latter, neoclassical economists struggled for some time to explain FDI, the primary stumbling block being the absence of an answer to the question why a firm would choose FDI, the most expensive option, over export or licensing. A revolution of sorts took place when Stephen Hymer (in his doctoral dissertation: Hymer 1976) suggested that firms undertaking FDI were not, as previously assumed, perfect competitors. Thus, the higher cost of transacting abroad was not sufficient to drive them out of the market. Furthermore, they may gain specific advantages from locating internationally (something a perfect competitor, by definition, could not do). The most productive extension of Hymer's theory has been that orchestrated by John Dunning (1977). Dunning insists that only an eclectic approach can hope to fully explain the phenomenon of FDI. Theories from economics, sociology, political science, and the business disciplines may each have something substantial to contribute to a complete understanding. His broad-minded attitude is not typical of neoclassical research, wherein analyses originating outside the economics are often discounted as unscientific. Nonetheless, he has been quite persuasive and influential.
Because the "'neoclassical' theory of direct foreign investment is not neoclassical at all" (Harvey 1989-90), Post Keynesians have not felt the need to rewrite orthodox FDI theory. One improvement they have made is to substitute Alfred Eichner's model of oligopoly for the mainstream's. In addition, the Post Keynesian focus on the role of uncertainty has had useful applications in FDI theory, especially with regard to exchange rate movements (Harvey 1989-90).
Most Institutionalist research has been confined to studies of FDI in developing countries (although there are exceptions). Unlike neoclassical economists, institutionalists do not view economic behavior as natural and therefore identical across social groups. Instead, because it is learned, the structure of each economy must be carefully studied before it can be understood. Hence, not only do institutionalists resist the temptation to use the same approach in every context, they also treat economic theory as a manifestation of cultural biases and folkviews. For example, it is argued that the mainstream bias in favor of free markets has led them to the erroneous conclusions that, first, the modern industrial economies developed more quickly when they were the recipients of inward FDI, and second, that today's Third World countries therefore need FDI to spur their development process (Mayhew 1996). As a consequence, it is quite often the case that the welfare of those being "helped" by FDI is lowered rather than raised.
Marxists share the concern of Institutionalists, albeit for quite different reasons. Classical Marxist theories of IMPERIALISM provided the first explanations of FDI:
a) The surplus of capital approach, which claims that in industrial countries while the volume of capital intended for accumulation increases rapidly, investment opportunities contract, forcing the export of capital (Hilferding 1981, p. 234).
b) The colonial extra profits approach, which claims that colonial or low developed - low wage countries become a source of extra profits by (...) reducing the cost price of industrial products and that, therefore, it is these territories which can have great importance for the most powerful capitalist groups (Hilferding 1981, p. 328).
However, the reality is that most FDI takes place among developed countries. Investment opportunities have not contracted in the industrial countries, and the comparatively low productivity of labour in the Third World has resulted in a low profit rate in these countries, despite the low labour or raw-materials costs (Milios 1989).
While determining why these two approaches have not worked may be interesting, the far more important issue for Marxists is explaining FDI among sectors of developed capitalist countries. FDI among industrial countries and its correlation with international trade was penetratingly investigated in Germany by several authors (Busch, Neusuess, Schoeller ...), who claimed that the Marxist law of value functions in a modified way on the world market (Busch et al 1984): FDI is undertaken, they claimed, by enterprises of a national economic sector which initially possesses a leading position in the world market. This sector acquires extra-profits by exporting commodities to foreign markets, where local producers possess a lower labour productivity. These extra-profits of the country with the higher labour productivity are, though, soon eroded, through an overvaluation of its national currency, due to its trade balance surpluses. Correspondingly, trade deficits lead to a devaluation of the currency of the less developed country. Now the advanced country's position in the foreign market is threatened by local producers, unless transposition of production in this foreign market (i.e. FDI) takes place.
Real term currency devaluation acts therefore protectively for the less developed industrial country as a whole and initiates inward FDI in it. However, sectors of this less advanced country, with a labour productivity exceeding the country's average, can acquire, through this exchange rate mechanism, an advantage (extra-profits) in international trade even with higher developed countries. The erosion of this advantage in international competition (e.g. through opposite exchange rate adjustments) may lead to flows of FDI from less developed to higher developed countries. FDI ceases to be mainly one-directional and becomes cross- directional, as productivity gaps between industrial countries diminish.
Selected References
Busch, K. (1974) Die Multinationalen Konzerne. Zur Analyse Der Weltmarktbewegung Des Kapitals, Frankfurt/M.
Busch, K., G. Grunert, W. Tobergte (1984) Strukturen Der Kapitalistischen Weltoekonomie, Saarbruecken.
Dunning, J.H. (1977) Trade, Location of Economic Activity and the MNE: A Search for an Eclectic Approach." In The International Allocation of Economic Activity, B. Ohlin, P.O. Hesselborn, and P.M. Wijkman, eds., London: The Macmillan Press.
Harvey, J.T. (1989-90) "The Determinants of Direct Foreign Investment." Journal of Post Keynesian Economics, 12(2), pp.260-272.
Hilferding, R. (1981) Finance Capital, London.
Hymer, S. (1976) the International Operations of National Firms: Study of Direct Foreign Invetment. Cambridge, Mass.: MIT Press. (Ph.D. Dissertation)
Mayhew, A. (1996) "Foreign Investment, Economic Growth, and Theories of Value." In The Institutional Economics of The International Economy, J. Adams and A. Scaperlanda, eds., Boston: Kluwer Academic Publishers.
Milios, J. (1989) "The Problem of Capitalist Development." In Gottdiener,M., N. Komninos, eds., Capitalist Development And Crisis Theory, London-New York.
Back to John Harvey Course Materials Page