Direct Foreign Investment: Costs and Benefits

By Richard D. Robinson | Go to book overview

Chapter One
Government Policy Options vis-à-vis Foreign Business Activity: An Academic View

Richard D. Robinson

In general terms, a government has only four administrative levers with which to encourage or discourage an enterprise, whether foreign or domestic, to do something it would not otherwise do: regulation, tax incentive, subsidy, and reduction or increase of uncertainty.

A government is inclined to intervene positively (that is, provide incentives) when it perceives, rightly or wrongly, that the external benefits expected from an enterprise's activities will not be reflected in its internal financial results, within the time relevant to a firm's decisions. Or, the government objective may be to prevent an enterprise from doing something that it would otherwise do, but which the government deems socially undesirable in the sense that the associated external costs are not reflected in the firm's internal financial results within the time frame of decisions. The assumption in either case is that an enterprise can be expected to respond only to the expected financial consequences of an activity, not to external costs and benefits. In such case, the government may impose disincentives. It is useful to consider the characteristics of these four administrative levers.


DEFINITIONS

Regulation , as a device to induce an enterprise to do something it would not otherwise undertake on its own volition (or the reverse), will work only if the enterprise perceives that, even though the act required may be less profitable than the prohibited alternatives, it is nonetheless sufficiently attractive in terms of anticipated financial results to warrant undertaking. If the enterprise has much to lose in the form of "sunk" cost (that is, expenditures already made that cannot be recovered), or is threatened with the loss of a significant market possessing the promise of future profit, then this approach may be effective--but at the possible cost of discouraging subsequent investors (new entrants). The discouragement will be particularly intense if the regulation is viewed as arbitary and changeable (that is,

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