Government Policy Instruments for Managing Foreign Direct Investment (FDI)

By their choice of policies, home countries can both encourage and restrict FDI by local firms. We look at policies designed to encourage outward FDI first. These include foreign risk insurance, tax incentives, and political pressure. Then we will look at policies designed to restrict outward FDI.

Home Country Policies to Encourage Outward FDI

Many investor nations now have government backed insurance programs to cover major types of foreign investment risks. The types of risks insurable through these programs include risks of expropriation (nationalization), war losses and the inability to transfer profit back home. Such programs are particularly useful in encouraging firms to undertake investments in politically unstable countries.

Home Country Policies to Restrict Outward FDI

Virtually all investor countries, including the US, have tried to exercise some control over outward FDI from time to time. One common policy has been to limit capital outflows out of certain concern for the country’s balance of payment. From the early 1960s until 1979, for example, Britain had exchange control regulations that limited the amount of capital a firm could take out of the country. Although the main intent was to improve the British balance of payments, an important secondary intent was to make it more difficult for British firms to undertake FDI.

In addition countries have manipulated tax rules to encourage their firms to invest at home. The objective behind such policies is to create jobs at home rather than in other nations. At one time the British taxed companies’ foreign earnings at a higher rate than their domestic earnings, creating an incentive for British companies to invest at home.

Finally, countries sometimes prohibit national firms from investing in certain countries for political reasons. Such restrictions can be formal or informal. For instance, formal rules have prohibited US firms from investing in countries such as Cuba, Libya and Iran, whose political ideology and actions are judged to be contrary to US interests.

Host Country Policies to Encourage Inward FDI

it is increasingly common for governments to offer incentives to foreign firms to invest in their countries. Such incentives take many forms, but the most common are tax concessions, low interest loans, grants or subsidies. Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI. They are also motivated by desire to capture FDI away from other potential host countries. Not only do countries compete with each other to attract FDI, but so do regions of countries.

Host Country Policies to Restrict Inward FDI

Host governments use a range of controls to restrict FDI. The two most common are ownership limitations and performance requirements. Ownership restraints can take several forms. In some countries foreign companies are excluded from certain businesses. For example, they are excluded from tobacco and mining in Sweden and from the development of certain natural resources in Brazil, Finland and Morocco. In other countries, foreign firms may only own up to a certain percentage of the shares in the local company.

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