What Do We Know about Greenfield FDI under Interstate Political Tensions?

• In Event: Political Risk and Foreign Direct Investment

Abstract

Does a decline in political relations deteriorate economic relations? In the context of greenfield foreign direct investment (FDI), we show that the answer to this question depends on the nature of both investment industries and multinationals. We argue that greenfield FDI is likely to persist despite deteriorating political relations between two countries when multinationals have high expected returns or strong economic ties with the host government. Specifically, political tensions are unlikely to change FDI in capital intensive industries due to the high expected returns, despite the high risk of expropriation, unless the deterioration in political relations is likely to cause a significant reduction in their expected returns. Furthermore, multinationals who have strong economic ties with the host government are unlikely to respond to political tensions due to the high sunk costs in building up the existing economic ties. Using firm-level greenfield FDI data from the fDi Markets database and ICEWS coded event data between 2003 and 2014, we show that political tensions discourage investment in less capital intensive industries like autos and apparel and have no influence on investment in capital intensive industries like oil and gas. Nevertheless, hostile political relations like embargoes and militarized actions attract less investment regardless of industry capital intensity. We also show that political tensions are less likely to shape FDI behavior of multinationals with established subsidiaries in the host country.

Authors

• Yoo Sun Jung, Texas A&M University

• Yohan Park, Texas A&M University