Nation-States and the Multinational Corporation: A Political Economy of Direct Foreign Investment

By Boudreaux, Donald J. | Independent Review, Summer 2007 | Go to article overview

Nation-States and the Multinational Corporation: A Political Economy of Direct Foreign Investment


Boudreaux, Donald J., Independent Review


Nation-States and the Multinational Corporation: A Political Economy of Direct Foreign Investment By Nathan M. Jensen Princeton, N.J.: Princeton University Press, 2006. Pp. xiv, 193. $35.00 cloth.

How do a country's political institutions influence the decisions of foreign investors to invest in that country-and, in particular, to invest in ways that give these investors control over the use of their invested resources? In Nation-States and the Multinational Corporation, Nathan Jensen tackles this question thoroughly and empirically. Jensen, an assistant professor of political science at Washington University, brings to this task considerable econometric skill, a workmanlike approach to asking questions and answering them patiently, and no evident political biases. His findings are credible, even compelling, without being banal.

Among his background assumptions is that "market-friendly policies" attract multinational corporations to make investments in a country, including direct investments (as opposed to "portfolio investments" in securities). This assumption makes sense. We need no econometric test to convince us that, for example, as the probability of the nationalization of oil wells increases in Venezuela, private firms will drill fewer oil wells there.

Jensen's contribution is to explore in detail the consequences that different political institutions have on foreign direct investment (FDI). These political institutions are not policies, such as a decision to nationalize industries, but something closer to what James Buchanan calls "constitutional rules"-rules of the game that determine the character of the ensuing political process. Because such rules determine the course of processes, they are more open-ended and have more dimensions than specific policies, and their effects on FDI are not as obvious or predictable as the effects of many specific policies. So a sound understanding of such institutions' effects requires empirical research.

Among Jensen's findings is how little government fiscal policies affect FDI. In a summary of his findings on this front, he states: "Little evidence exists that government spending or taxation levels have a negative effect on FDI inflows. Government devotion to social security, often characterized as economically unproductive market intervention, does not deter multinational investments. More generally left-wing governments do not suffer from lower levels of FDI inflows. In sum, multinational corporations' investment decisions do not seriously challenge government fiscal policy autonomy" (p. 54). These findings are not as surprising as they initially appear. Just as low wage rates are generally insufficient to attract huge investments, so, too, are low taxes. Of course, all other things being equal, firms prefer to pay lower rather than higher wage rates and, as Jensen readily acknowledges, lower rather than higher taxes. But "all other things being equal" looms large here because all other things generally are not equal.

Low wage rates, for example, usually signal low worker productivity. Once this low productivity is revealed, it is easy to understood why firms generally prefer to invest where wages are higher rather than where they are lower. Likewise with taxes, which are often (though by no means always) higher in countries that have more secure property rights. It is not at all surprising that the attraction of secure property rights can and often does swamp the repulsion of high taxes. Indeed, it is my sense that security of property rights goes a very long way toward reducing the ill effects of other harmful government interventions. (This sense, by the way, forms my theory of why France is as prosperous as it is!)

Jensen correctly interprets his findings as casting deep doubt on the "race to the bottom" thesis, which holds that competition among governments to attract increasingly mobile capital from around the world forces them to slash taxes, reduce spending, and repeal regulations that add to the cost of doing business. …

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