How Do Economic Sanctions Affect Foreign Direct Investments (FDI)?


Literature Review, 2020

12 Pages, Grade: A


Excerpt

Introduction

There are intense debates around effectiveness of economic sanctions in political economy. Sanctioned governments are being under pressure of travel bans, financial restrictions, military coercion, surviving in a difficult economic situations and being forced to change policies and seek compromises. It is well studied that economic coercions have a negative effects on target states economies, especially with military interventions. But what is the effect of sanctions for countries which impose those sanctions having FDI inflow in targeted economies?

The main question of all collected articles is relationship between economic sanctions and foreign direct investment (FDI). The objective is to highlight how FDI has been negatively or positively affected in targeted countries and how investors benefit from FDI. All articles used literature reviews and empirical analyses based on time-series cross-national data. The critical analysis of the study will be divided into 3 categories: 1. Unilateral and bilateral sanctions which describe relations between a sender and a target 2. The role of third-party countries in terms of cooperation as allies or rivals who undertake the dominant position of a sender 3. Important aspects when sanctions are effective to be imposed such as aspect of time (short or long-run), a degree of economic pain (military or economic coercion), entry mode (through multilateral corporations or join ventures), competitiveness of firms and the value of exchange rate.

1. A sender vs. a targeted country. Loss or benefits?

Restrictions and barriers can be seen as business opportunities for multinational corporations at some point. FDI flows could help to substitute for a large share of import flows and loaned financial resources. G.Biglaiser and D.Lektzian brought the evidence of the hypothesis that in order to avoid the risk US investors withdraw prior from investment which is followed by support of US government and international organizations. “Once the sanctions placed investors would like to get lowered costs using “fire sales” followed by crisis, then a host country opens doors to investors to increase profit opportunities. Investors also have a great profit when sanctions are in effect” (G. Biglaiser, D.Lektzian 2011). Basically under sanctions investors feel balanced and backed up by the support of a government and IO, and they play “buy low, sell high” which leads to successful return.

In the another article they brought another hypothesis towards effect of FDI decisions on the success of sanctions. The authors admit that if global FDI increases while US FDI falls down, the US won’t be effective enough to punish target countries which leads to unsuccessful and less effective sanctions. For example, when US imposed sanctions against Cuba, Soviet Union backed up and provided the aid. Even after the Soviet Union collapse Cuba found Venezuela as a new donor. The authors do not mention about the effectiveness of multilateral sanctions. But in conclusion they point out that the US FDI case does not apply to global FDI, but US sanctions are highly relevant and US investors act as “black knights” who can prevent sanction attempts by other countries (G.Biglaiser, D.Lektzian, 2014). The question of effectiveness of US sanctions towards global FDI arises here. Would other foreign companies create opportunities when US disinvest from the sanctions imposed country? Or would it be too risky for global investors to step up on a vacated role which might lead to a global decline in investment?

2. Third-party countries. Allies or competitors?

G. Biglaiser and D.Lektzian in their third article brought up the evidence that third party countries benefit from US FDI disinvestment from targeted country and they see it as a business opportunity. Moreover, sanctioned countries are able to attract global investors as replacement of US FDI and compensate their losses under the pressure of sanctions. (G.Biglaiser, D. Letktzian, 2013). For example, while US companies are blocked from Iran’s oil reserves, other countries such as Norway, Austria, China and Malaysia enjoy their business opportunities in Iran. When the US tried to apply its sanction policies to third-party extraterritorial sanctions, but as the result it was impossible to convince the third-party countries to do so. US cannot punish foreign companies but how could they could convince them to disinvest? In my opinion authors need to research more about relationship between variables as extraterritorial sanctions and allies among third-party countries.

H.L.Frank and L.W.Wang brought the evidence that US extraterritorial sanctions have a negative effect on FDI which can lead to loss of leader’s status in global economy and relationships with international trade allies like EU, Canada and Mexico placing US companies at risk of legal double jeopardy. Also international collaboration needed to advance U.S. national security and foreign policy interests including coordination to suppress international terrorism. (H.L.Frank, L.W.Wang 2007) So how US could convince foreign countries to disinvest if extraterritorial sanctions do not work?

M. Bussmann found a hypothesis that foreign investors make decisions based on risk assessments. If it’s too risky to invest in a targeted country due to military interventions or other coercions then companies may choose to take their investments to a safer places. “Location decisions of investors are driven not only by the economic policy of the targeted country but also by the political risk involved” (M.Bussmann, 2010). G.Biglaiser and Lektzian support this argument as well but they do not provide evidence. M.Bussmann provides evidence that FDI inflows are attractive to a host country so they avoid conflicts and create peaceful environment for FDI. The results of the study shows that FDI inflows and stock reduce the risk of beginning of the fatal dispute. With this being said the same argument about political risk of both articles could be used in different determinants. G.Biglaiser and Lektzian is on the side of US investors benefiting from sanctions and M.Bussmann researches from the perspective of how FDI can prevent sanctions and attract liberal foreign policies. If the extraterritorial sanctions is not a good option, then how about making a cooperation with those third-party countries and benefit from their FDI and a targeted country?

The article of C.Barry and K.Kleinberg hypothesize that in response to sanctions imposition against a trading partner, sender-state multinational corporations will shift FDI to third-party states, which are basically competitors. When investors make political risks analysis they predict that sender-state companies might need a rent-seeking opportunity as a back up. In globalization home and host countries encourage their companies to look for indirect access to third-party countries which leads to continuous business engagement with a targeted country. (C.Barry, K.Kleinberg, 2015). Basically, sender state companies reroute their exchange with a target state through third-party countries and they can even sell same products with higher prices. Moreover, the authors even recommend to increase the volume of sender-state capital flows into third-party countries which has ties with a targeted country. Here is the question of investors mindset and strategies arises. All previous authors (except C.Barry and K.Kleinberg), did not take into consideration that it’s not only about relationship between a sender and a targeted country, it’s also factors that reflect the host’s position against other states in the global economy.

Contrary E.McLean and T.Whang have a point that it is better to stay against a targeted country but to make cooperation with allies at the same time. The authors bring a hypothesis that international assistance to a target country may come not only from third-third-party countries which help to exchange goods and services before sanctions were imposed, but also from small trading partners so called “black knights” that help a targeted country during the sanctioning period to strengthen the economy. Economic sanctions for these “black knights” bring opportunities quickly to enter the market previously dominated by companies from a sender country. Even well-coordinated sanctions may fail if too many black-knights will interfere and lower down the costs of economic sanctions. The authors recommend that it is better to cooperate with third-party countries in allies against a targeted country and convince them to impose more sanctions so a targeted country would fall into position of a “deadlock”. (E.McLean, T.Whang 2010)

B. Early agrees that third-party countries and so called “black knights” are sanctions busters but it depends on how profitable a third-party country’s bilateral trade with a target country and the degree to which two states’ trade increases after a targeted country is sanctioned. (B.Early, 2009). The author’s study shows that basically sanction-busting is the product of calculated responses by profit driven firms which explains the behavior of third-party towards a targeted state. This actually explains why third-party countries want to impose sanctions along with a sender or refuse to do so. I think the author brought up the important aspect of effectiveness of third-party cooperation in terms of their interest in profit and not only from political and security demands. The results of this article show that sender’s closest allies are busting sanctions than are its competitors. So instead of blaming enemies why sanctions have been failed a sender should pay attention to its allies as well.

3. Important aspects of effectiveness of sanctions.

Previous articles missed the important aspect how FDI changes over time and the effectiveness of sanctions can be changed by time. Kaempfer and Lowenberg describe a theoretical model of how short-run sanctions effect on FDI, and how it would be different from those in the long run which leads to the increase of return right away after sanctions being imposed. But this would also lead to a higher production costs and lower profits when the capital resources are over. Once a target economy balances out, the effect of sanctions on FDI might be different in the direction and magnitude. (Kaempfer and Lowenberg, 2007)

I.Mirkina supports this point about short and long-run sanctions adding that it depends on costs. High costs sanctions have a negative effect in FDI in the short-run, and they are not effective in long-run. Low-cost sanctions never produce a significant product of investment. For example, US sanctions have a negative effect in the long run, even previous authors stated that the role of US as a leader of global sanctions, most of them actually are not that effective after years. She brings the hypothesis that US investors are slower in making decisions when it comes to withdraw in unilateral sanctions than when they deal with multilateral sanctions. This might lead to delays in the adjustment of the target economy to a new equilibrium. (I.Mirkina, 2018). With this finding another question arises - what’s the mutual impact of US sanctions and US FDI.

Another important aspect of sanction effectiveness is a degree of economic pain. G. Shin, S. Choi and Luo examine how degree of economics damage affect on international trade, international portfolio and investment and FDI. The analysis show that economic sanctions do not affect FDI and trade, whether sanctions are unilateral or multilateral coalition, financial severe cost type or embargo. Basically if sanctions have non-military strategy, which is a low-degree of effectiveness, it will not lead to an economic pain in a targeted country. (G.Shin, S.Chi and Luo 2016). While previous studies of Lektzian, Biglaiser and Mirkina pointed out that if sanctions are just severe enough they will damage economy of a targeted country which will lead to a harm of FDI as well. Moreover, they argue that it is difficult to find out what is the outcome from economic sanctions without researching how exactly sanctions can affect the economic well-being of a target country. This is the reason that it has to be studied according to the performance of the economy in important areas such as international trade, FDI portfolio and FDI. The authors point is that there is no way to measure effectiveness of sanctions without researching mentioned variables above.

The article of D. Kim describes another important aspect of entry mode of FDI which reflects the impact of FDI on the use of sanctions. He argues that the effects of FDI are different depending on how FDI enters a targeted country with multinational corporations or joint ventures. Multinational corporations have a wholly-owned subsidiaries with a targeted country so they are more tied up and it is harder for them to disinvest due to high costs compare to joint ventures. More than that if multinational corporations withdraw with big losses from a targeted company’s market the parent will be affected though stock market rather than joint ventures. FDI through joint ventures are open to make domestic companies and even government shareholders of FDI. Moreover, FDI through joint ventures benefits when sanctions are imposed to a targeted country because costs will be much higher than other types of economic ties not created by FDI. But the most important is that costs of joint venture is way less costly for a sender. (D.Kim, 2011). With this being said D.Kim found out an important variable of entry mode of FDI and apparently entering with joint ventures creates a situation where a targeted country is dependent on a sender or at least depends on a sender’s demands at some point.

N.Bapat and B. Kwon study an aspect of sender’s firms competitiveness in order to succeed in economic sanction imposition. Sanctions may be imposed for political reasons. A sender chases the real policy change from a targeted country only when sender’s firms have a low FDI on a target’s market. In this case a targeted country wouldn’t respond to sanctions threats. Even though a sender impose sanctions due to a domestic pressure, these sanctions won’t bring a real outcome. But when a sender has a big share of FDI in the targeted country’s market then their exchanges may bring a high profit so the imposition of sanctions fall apart to be unenforceable. All this leads to the fact that a sender is not able to stop the firms to cooperate with a targeted country, and prevent them from getting the high share of FDI and letting foreign competitors to replace them (N.A. Bapat and B.R. Kwon, 2015). With this being said a sender is less able to impose sanctions if its FDI are dominated on a target’s market. This leads to a demand on cooperation between a sender and private actors. I think a sender have to be concerned about competitiveness of its firms, the amount of money they invest and return home, what are their future business perspectives instead of imposing sanctions aggressively.

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Excerpt out of 12 pages

Details

Title
How Do Economic Sanctions Affect Foreign Direct Investments (FDI)?
College
City University of New York City College  (CCNY)
Course
International Relations
Grade
A
Author
Year
2020
Pages
12
Catalog Number
V907119
ISBN (eBook)
9783346240866
ISBN (Book)
9783346240873
Language
English
Tags
international relations, economics, international economics, FDI, economic sanctions
Quote paper
Liliya Kenzhebayeva (Author), 2020, How Do Economic Sanctions Affect Foreign Direct Investments (FDI)?, Munich, GRIN Verlag, https://www.grin.com/document/907119

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