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

Why do countries seek to attract foreign investors, such as multinational corporations (MNCs)? From production to technology, MNCs have positive spillover effects on the global economy, creating employment and enhancing the host country’s growth prospects. In Nation-States and the Multinational Corporation, Jensen focuses on the influence of government policies and political institutions on MNC investments. Jensen believes that political institutions, not government fiscal policies (e.g., spending and taxation), are the most important determinants of foreign direct investment (FDI) flows. Tellingly, democratic institutions that provide the promise of “market friendly” policies and politically federal institutions that give regional units like states more representation at the national level are more likely to attract FDI flows. On the other hand, Jensen argues, countries participating in agreements with the International Monetary Fund (IMF), other than in cases of severe economic crisis, lead to lower levels of FDI flows.

Jensen criticizes race to the bottom (RTB) theory based on perfectly competitive markets that assumes capital mobility—multinationals depart to countries with better fiscal policy. Rather, he supports the notion that markets are imperfect (following Stephen H. Hymer, International Operations of Foreign Firms, 1976), in that MNC investments are immobile ex post. Jensen theorizes that multinationals face political risk, which is defined as the political factors that adversely affect profit, such as “war and political violence, expropriation, breach of contract, and transfer risk” (p. 49). After MNCs have sunk investments, governments have the ability to renege and renegotiate contracts due to “obsolescing bargaining power” (as defined by Raymond Vernon, Sovereignty at Bay, 1971). Hence, Jensen emphasizes that multinationals choose to enter countries with minimal political risk and stable economic policy.

Jensen validates his theory and findings based on quantitative and qualitative results on FDI flows: for the former, he analyzes data drawn from multiple sources on over a hundred countries from the 1970s to the 1990s, and for the latter, he interviews multinationals, agencies, consultants, and analysts. According to Jensen, the existing literature has overemphasized the effect of fiscal policy on FDI flows, and he challenges the RTB theory that countries fiscally compete for MNC investments. He finds that government fiscal policy has no significant effect on FDI flows (Chapter 4). As opposed to authoritarian regimes, Jensen indicates that democratic institutions provide both the commitment and credibility in the “market friendly” environment.

MNCs will favor democratic environments where the firm can influence policy through lobbying efforts and other institutional features. Jensen finds that democratic institutions attract more FDI (Chapter 5), and motivates his findings with an Alcan and Brazil case study. Alcan Corporation’s energy operations in Brazil were extensive and not mobile when the Brazilian central government proposed increased energy transmission surcharges. Since Brazil is a democracy, providing avenues for political influence, Alcan rallied with other multinationals and propelled Brazilian associations to protest the surcharges against the government.

Further, Jensen explains that political institutions that support politically federal systems will help managers of MNCs to forecast and follow through on their investment decisions. Politically federal systems are political systems where regional actors, such as states, have more representation and can affect national policy. Politically federal systems positively affect FDI flows (Chapter 6), though there are mixed results for veto players, which include courts, legislative branches, and federal actors that establish checks and balances and may enhance the credibility of host governments.

Jensen covers the IMF’s promotion of macroeconomic reform for political stability, and how the effects are unclear and not conducive to MNCs or long-run economic growth. The IMF’s purpose is to make finance available to nations that are unable to attract capital through market mechanisms. However, Jensen finds that IMF agreements have a negative and significant impact on FDI flows.

The underlying theme of the book is that institutions that provide political stability will attract foreign investors. In addition to...