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Sovereignty en garde: negotiating with foreign investors

Published online by Cambridge University Press:  22 May 2009

Dennis J. Encarnation  and
Louis T. Wells Jr
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Governments must choose between general policies and individual negotiations to reach agreements with foreign investors. General policy leaves nothing to be negotiated. But once negotiation is selected, governments face difficult choices over how to conduct ne otiations. No single choice of organizational structure or administrative process is optimal for all countries or for all industries. Each organizational choice carries a range of economic and political costs and benefits that are valued differently by the domestic and foreign interests affected by the negotiation's outcome. Interviews with government officials in four Asian countries and corporate executives in four industries, all involved in international business negotiations between 1978 and 1982, demonstrate that different governments should and do choose different approaches to negotiating with foreign firms. Even single countries use different approaches at different times and with different industries. Moreover, the managerial choices of structure and process are not random. Rather, they are influenced by a government's general strategy toward foreign investment, the “political salience” of a given investment, and the degree of competition among countries for a specific investment. Ultimately, a government's management of international business negotiations shapes its effectiveness in negotiating with foreign firms and in competing for foreign investment.

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Articles
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International Organization , Volume 39 , Issue 1 , Winter 1985 , pp. 47 - 78
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Copyright © The IO Foundation 1985

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References

1. For an overview of investment incentives in industrialized countries, see OECD, Committee on International Investment and Multinational Enterprises, “Survey on Investment Incentive Policies in Member Countries” (Paris: OECD, 05 1982)Google Scholar. For an overview of such policies in economically less developed countries, see Lent, George E., “Fiscal and Other Measures to Promote Industry in Developing Countries” (Paris: OECD, 11 1980)Google Scholar. Aside from the few systematic analyses, data on investment incentives may be garnered from innumerable catalogues of these policies. For the EEC, see Yuill, Douglas and Allen, Kevin, eds., European Regional Incentives: 1981 (Glasgow: Centre for the Study of Public Policy, University of Strath-clyde, 1981)Google Scholar. For south and east Asia, see the SGV Group, Comparative Investment Incentives: 1981 (Manila: SGV Development Center, 1981).Google Scholar

2. Bergsten, C. Fred, “Coming Foreign Investment Wars,” Foreign Affairs, 10 1974, pp. 135–52.CrossRefGoogle Scholar

3. See Encarnation, Dennis J. and Wells, Louis T. Jr., “Competitive Strategies in Global Industries: A View from the Host Country,” in Porter, Michael E., ed., Competition in Global Industries (Boston: Harvard Business School Press, 1985)Google Scholar; Guisinger, Stephen, “Investment Incentives and Performance Requirements: A Comparative Analysis of Country Foreign Investment Strategies,” mimeo (Washington: International Finance Corporation, 07 1983)Google Scholar; and Lessard, Donald, “Specific Incentives for Direct Foreign Investment,” mimeo (Washington: International Finance Corporation, 01 1978).Google Scholar

4. The most widely held conclusion among researchers is that tariff and tariff-equivalent trade barriers serve as important stimuli for most investments designed to service a domestic or common market. For these investments, tax and other incentives may influence the final location within a national or regional market but not the prior decision to enter that market. By contrast, for export-oriented investments, especially investments characterized by mobile factors of production, tax and other incentives may play a larger role in the initial choice of location sites. Such investments, whether they serve regional or global markets, are often the targets of intense competition among potential host countries. For an early review of this literature, see Reuber, Grant L. et al. , Foreign Private Investment in Development (Oxford: Oxford University Press for the OECD, 1973), pp. 120–32Google Scholar. For a more recent review, see Encarnation, and Wells, , “Competitive Strategies in Industries.”Google Scholar

5. When managers of foreign firms are asked to rank-order those factors which are important to their investment decision, one consistent conclusion emerges. Irrespective of host country or manufacturing industry, managers consistently rank political and administrative concerns as more important than government incentives. These general concerns figure prominently in managers' appraisals of the overall “investment climate” of the host country. For a summary of and addition to this research, see Kobrin, Stephen J., Managing Political Risk Assessment (Berkeley: University of California Press, 1982), pp. 114–20.Google Scholar

6. With regard to economic costs, the frequency of unattractive investments in LDCs is suggested in Reuber, et al. , Foreign Private Investment, pp. 17–39Google Scholar. For more recent evidence employing social cost/benefit analysis of data covering 50 foreign-investment decisions, see Encarnation, Dennis J. and Wells, Louis T. Jr., “A Mixed Bag: Foreign Private Investment in Development,” Harvard Business School Working Paper (Boston, 1985).Google Scholar

7. Quoted in the Economist, 19 February 1983, p. 86.Google Scholar

8. See Kobrin, , Managing Political Risk Assessment, pp. 109–24Google Scholar. We are also familiar with numerous examples. In one case a U.S.-based oil company spent months negotiating with a state enterprise for a contract for a hard mineral. The fact that the state firm had no power to reach an agreement was not understood by the investor, who had simply extrapolated from the firm's experience in oil in the same country; for in oil the state oil firm could conclude agreements.

9. Vaitsos, Constantine, Intercountry Income Distribution and Transnational Enterprises (Oxford: Clarendon Press, 1974), p. 122Google Scholar; Lall, Sanjaya and Streeten, Paul, Foreign Investment, Transnational and Developing Countries (London: Macmillan, 1977), p. 217.CrossRefGoogle Scholar

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11. Southeast Asian countries, for example, are strewn with proposals for creating or modifying boards of investment and related bodies. To illustrate, see Guisinger, Stephen A., “Investment Incentive Strategies for Thailand's Industrial Development,” mimeo; (Washington, D.C.: World Bank, 1980).Google Scholar

12. For example, Grieco, Joseph M., “Between Dependence and Autonomy: India's Experience with the International Computer Industry,” International Organization 36 (Summer 1982), pp. 609–32CrossRefGoogle Scholar, and Gary Gereffi, “Drug Firms and Dependency in Mexico: The Case of the Steroid Hormone Industry,” ibid. 32 (Winter 1978), pp. 237–86.

13. See, for example, Kobrin, Stephen J., “Foreign Enterprise and Forced Divestment in LDCs,” International Organization 32 (Winter 1980), pp. 65–88.CrossRefGoogle Scholar

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17. Grieco, , “Between Dependence and Autonomy”Google Scholar; Fagre, and Wells, , “Bargaining Power.”Google Scholar

18. Encarnation, Dennis J. and Vachani, Sushil, “Creative Responses to a Hostile Environment: MNCs in India,” Harvard Business School Working Paper (Boston, 01 1984)Google Scholar; Fagre, and Wells, , “Bargaining Power.”Google Scholar

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20. Encarnation, Dennis J., “‘;Self-Reliant’ Development: The Political Economy of Industrial Policy in India” (manuscript, 1984)Google Scholar; Zysman, John, “The French State in the International Economy,” in Katzenstein, Peter J., ed., Between Power and Plenty (Madison: University of Wisconsin Press, 1978), pp. 255–93.Google Scholar

21. Lall, and Streeten, , Foreign Investment, p. 217Google Scholar; UN, Impact of Multinational Corporations, p. 38.Google Scholar

22. Lall, and Streeten, , Foreign Investment, p. 217.Google Scholar

23. For an original exposition of this hypothesis, see Niskanen, William A. Jr., Bureaucracy and Representative Government (Chicago: Aldine-Atherton, 1971).Google Scholar

24. For a review of this literature, see Encarnation, Dennis J., “William Niskanen on Bureaucratic Responsiveness: An Empirical Analysis,” Harvard Business School Working Paper (Boston, 01 1983).Google Scholar

25. Allison, Graham T., Essence of Decision: Explaining the Cuban Missile Crisis (Boston: Little, Brown, 1971)Google Scholar; Wildavsky, Aaron, The Politics of the Budgetary Process, 2d ed. (Boston: Little, Brown, 1974).Google Scholar

26. For a review of this literature, see Salamon, Lester M. and Walmsley, Gary L., “The Federal Bureaucracy: Responsive to Whom?” in Riesalback, Leroy N., ed., People vs. Government: The Responsiveness of American Institutions (Bloomington: Indiana University Press, 1975), pp. 151–88.Google Scholar

27. Several studies ignore variation in negotiations across industries. They include Aharoni, Yair, The Foreign Investment Decision Process (Boston: Harvard Business School, 1966)Google Scholar; Kapoor, Ashok, International Business Negotiations (New York: New York University Press, 1970)Google Scholar; Stoever, William A., Renegotiations in International Business Transactions (Lexington, Mass.: Lexington Books, 1981)Google Scholar. Other studies ignore variations in negotiations across countries. They include Lombard, Francois J., “Screening Foreign Direct Investment in LDCs: Empirical Findings in the Colombian Case (1967–75),” Journal of International Business Studies 9 (Winter 1978), pp. 66–80CrossRefGoogle Scholar, and his The Foreign Investment Screening Process in LDCs: The Case of Colombia (Boulder: Westview, 1979).Google Scholar

28. See, for example, Robinson, Richard D., National Control of Foreign Business Entry (New York: Praeger, 1976).Google Scholar

29. “Greenfield” investments were defined as new investments requiring the fresh inflow of foreign equity and loans and not involving expansion or reinvestment by existing foreign investors.

30. Fagre, and Wells, , “Bargaining Power.” Case studies of bargaining relations between host countries and foreign firms further demonstrate the importance of these variables; see note 12 for citations.Google Scholar

31. For a good examination of the role of incentives and performance requirements in shaping foreign investment in this particular industry, see Gray, H. Peter and Walter, Ingo, “Investment-Related Trade Distortions in Petro-chemicals,” Journal of World Trade Law 17, 4 (1983), pp. 283–307.Google Scholar

32. Low-tech food products contrast with high-tech computers; huge petrochemical investments contrast with small facilities used in the manufacture of computers and food products; the export potential of computers contrasts with the short-term spoilage of milk-based products or the worldwide glut of petrochemicals; the paucity of overseas computer investments contrasts with the recent spate of diesel-engine negotiations.

33. Export-led Singapore with its small domestic market contrasts with import-substituting Indonesia or India with its large market; the strategies of “self-reliant” investment pursued by India and Indonesia contrast with the heavy use of external finance by Singapore and the Philippines.

34. General surveys of government strategies and structures for negotiating with foreign investors may be found in several sources. For an overview of all four countries in our study, see U.S., Department of Commerce, Investment Climate Statements: Major Trading and Investment Partners (Washington, D.C.: International Trade Administration, 04 1981)Google Scholar, and Incentives and Performance Requirements for Foreign Direct Investments in Selected Countries (Washington, D.C.: Domestic and International Business Administration, January 1978)Google Scholar; UN Centre on Transnational Corporations, Foreign Investment Policies and Screening and Monitoring Procedures in Selected Developing Countries (New York: UNCTC n.d.)Google Scholar, and National Legislation and Regulations relating to Transnational Corporations: Part I and Part II (New York: UNCTC, 1983)Google Scholar. For surveys of Indonesia, the Philippines, and Singapore, see Guisinger, , “Investment Incentive Strategies,”Google Scholar as well as Robinson, Richard D., Foreign Investment in the Third World: A Comparative Study of Selected Developing Country Investment Promotion Programs (Washington, D.C.: U.S. Chamber of Commerce, 1980)Google Scholar. Individual country profiles can also be obtained from consulting groups; for example, SGV Group, Comparative Investment Incentives.Google Scholar

35. For the interplay of policy experts and policy constituencies in business-government negotiations in one of the countries we examined, see Encarnation, Dennis J., “The Indian Central Bureaucracy: Responsive to Whom?” Asian Survey 19 (11 1979), pp. 1126–45.CrossRefGoogle Scholar

36. For a discussion of the similarities in competitive strategies between governments and private corporations, see Encarnation, and Wells, , “Competitive Strategies in Global Industries.”Google Scholar

37. One response of governments to what appears to be counterproductive warfare is to negotiate understandings with other governments to refrain from granting excessive financial incentives. Within the EEC, for example, agreements exist on the maximum “grant equivalent” that may be offered to attract investors. Similarly, the Andean Group has set bounds on offers to investors. Such agreements are, however, particularly difficult to reach and to enforce. Even in the face of explicit agreements among countries to limit competition, as in Europe, competition for certain types of foreign investment remains intense because of the relative magnitude of the stakes. When competition is fierce, governments are likely to try all types of financial incentives and marketing tools to achieve their objectives. The number of potential policies and tools for bidding is so great that agreements usually are quickly undermined. Moreover, once one country is successful in attracting foreign investment through the use of financial incentives and marketing tools, other governments will often follow that lead.

38. See Reuber, et al. , Foreign Private InvestmentGoogle Scholar; Lall, and Streeten, , Foreign InvestmentGoogle Scholar; and Encarnation, and Wells, , “A Mixed Bag.” Despite their differences, these three studies are consistent in reporting that nearly 40% of proposed import-substituting projects are harmful for the domestic economy.Google Scholar

39. For surveys of what LDC governments say they do, see the citations in note 34; for a single-country study with findings consistent with our framework, see Lombard on Colombia in his Foreign Investment Screening Process.

40. For France, Ireland, and the United Kingdom, see Amsalem, Michael A., “Investment Incentives and Performance Requirements in Europe,” mimeo (Washington: International Finance Corporation, 1982)Google Scholar; for Japan, see Johnson, Chalmers, MITI and the Japanese Miracle (Berkeley: University of California Press, 1982), especially pp. 275–304.Google Scholar