Political Tradition, Political Risk and Foreign Direct Investment in Italy

By Mudambi, Ram; Navarra, Pietro | Management International Review, July 2003 | Go to article overview

Political Tradition, Political Risk and Foreign Direct Investment in Italy


Mudambi, Ram, Navarra, Pietro, Management International Review


Abstract

* One the major recent trends in international business has been the recognition by governments of multinational enterprises (MNEs) as sources of scarce investment funds and desirable high value added jobs. Does a region's political tradition affect political risk perceived by MNEs? The effect of the local political tradition is not easy to isolate, since locations differ in many dimensions. Therefore, we address this question by examining MNE investment location decisions within a single country.

* The country we examine is Italy, where regional political traditions are extremely diverse. We estimate a two-step econometric model that is able to assess the impact of government political orientation in a three-way categorization, i.e., whether it is a major factor, a marginal factor or of no importance whatsoever.

Key Results

* We find that the major influence on the location of investment emanates from locational and infrastructural factors, while local political tradition is influential at the margin. This is not to say that political orientation is unimportant. There is evidence that most MNE investment location involves the short-listing of generally very competitive locations. Thus political orientation will play a key role in a choice from a short list of sites where the major locational parameters are very similar.

Introduction

In the post-Soviet era, governments of all hues tend to view multinational enterprises (MNEs) as sources of scarce investment funds and desirable high value added jobs (UNCTAD 1997). The ideal MNE investment from the point of view of the local government consists of a single facility with regional and preferably global R&D, production and marketing responsibility. Such a facility is a large employer, with a highly skilled, productive, and high-wage workforce, and a high level of local purchases to generate macro multiplier effects (Young/Hood/Peters 1994). Whether or not the government takes an activist role in attracting MNE investment, ensuring that the investment is close to the ideal requires an understanding of the forces that underlie the multinational mode of operation (Mudambi 1998).

In their seminal work, Buckley and Casson (1976) analyze the MNE using the tools of transaction cost economics developed by Coase (1937). Here, the MNE is seen as a form of hierarchical international organization that is put in place when the transaction costs involved with using market operations, typically through exports, become too high. Dunning's (1980, 1988) eclectic or O-L-I paradigm, under which MNE investment decisions are based on ownership, location and/or internalization advantages, can be seen as an means of fleshing out the transaction costs involved in international activity. In the literature, the role of the government is typically subsumed within the location dimension (Davidson 1980, Loree/Guisinger 1995, Mudambi 1995). Thus, the government may increase a location's attractiveness to MNE investors either directly, by providing investment supports, or indirectly by improving the location's fundamental advantages, i.e., its infrastructure and labor force.

Direct incentives to invest may well be viewed with suspicion by MNEs that may fear less favorable treatment once investments are in place and their bargaining position is considerably weakened--the so-called 'obsolescing bargain' (Vernon 1971). This question also affects the evaluation of the raw measures of location specific advantage. Brewer (1992) finds that MNE-government relations tend to be characterized by a mixture of cooperation (in relation to issues such as investment supports) and conflict (in relation to issues such as regulation). He is mainly concerned with tangible issues that have tangible effects.

Previous studies of the role of political factors on MNE investment decisions have focused on this issue of risk. For example, it has been pointed out that an unstable political climate does not necessarily equate with an unprofitable investment potential and that political risk must be treated like another component of business risk (Kobrin 1979, Simon 1984).

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