Impact of Political Risk on Foreign Direct Investment Decisions: Introduction

Chapter 1: Introduction

The purpose of this research is to investigate the impact of political risk on foreign direct investment decisions (FDI) by multinational corporations (MNCs). This introductory chapter provides an overview of the investigations research background, its aims and objectives, the research questions, methodology, the significance of the study. And provides a short account of the remaining chapters in this dissertation.

1.1: Background to the Research

FDI has been a subject of interest for economic theorists and policy makers for decades. In the years after the Second World War, global FDI was dominated by the USA – who had a uniquely powerful position. While much of the world had experienced extensive destruction and loss of life, no battles had been fought on US soil (Jones, 2005). As such, the USA accounted for around three-quarters of new FDI between 1945 and 1960. Since then, FDI has spread to become a global phenomenon. One that is no longer the exclusive reserve of the Organisation for Economic Co-operation and Development (OECD) countries. In present day, emerging economies such Brazil, China, India and Russia have become crucial players in the field (Wolf, 2018). The United Nations Conference on Trade (UNCTAD) acknowledged that cross-border investments by MNCs around the world have still not returned to their pre-crisis peak, ten years after the 2008 global financial crisis (Donnan, 2017). Despite this, FDI has grown significantly in the global economy with stocks of FDI representing about one third of the world’s economic output (Eurostat, 2018).

FDI is considered an integral part of an open and effective international economic system and a major catalyst to development (OECD, 2002). Most countries have undergone liberalisation in their policies regarding inward investment; easing restrictions and offering tax incentives and subsidies to attract foreign capital (Aitken and Harrison, 1999). Barrell and Holland (2002) acknowledge that FDI’s importance lies in its critical difference from other forms of capital investment: firstly, FDI flows are not as volatile as other types of capital flows and secondly, the duration of the commitment it involves.

The significant increase in FDI as well as the notable growth of MNCs activities across countries has been recognised as one of the most visible signs of increasing globalisation (Hirst et al., 2015).  Recent data highlights that most international investments have rotated away from emerging economies such as China and back into older, wealthier developed countries and regions in Europe and to the US (Financial Times, 2017).

In the light of globalisation and domestic market saturation MNCs face an increasingly competitive landscape, seeking to expand their operations and increase their investment opportunities outside home country. While foreign investment opportunities can be extremely rewarding, entering new markets and unfamiliar business environments can expose MNCs to new uncertainties. One of the key uncertainties of the current decade is political stability within countries, as well as between countries. While political instability within a country is commonly associated with fragile states such as Russia and Syria, it is a multidimensional construct that can also be applied to developed countries as well. Given the importance of political instability, it is somehow surprising that the impact of political risk in a host country on FDI remain unclear. Whilst survey evidence highlights that MNCs and investors do consider political instability as a major risk in the context of FDI, empirical studies often provide conflicting results. Therefore, it is one of the main objectives of this dissertation is to try and solve this intellectual puzzle in economic and political science literature by investigating the impact of political risk on FDI decisions by MNCs.

1.2: Research Aims and Objectives 

The overall aim of this dissertation is twofold: firstly, to investigate impact of political risk on FDI decisions by MNCs and secondly, to identify which determinants are most successful in attracting inflows of FDI into a country and thereby contribute to existing research.

The research objectives are as follows:

1. To determine the key determinants of FDI.
2. To analyse the data through comparison with research to date on the types of political risks MNCs face
3. To determine how MNCs manage political risks
4. To reflect the extent to which political risk impacts FDI decisions by MNCs.
5. determining the risk factors that affect inflow of FDI into countries

1.3:  Research Questions

The research seeks to answer the questions outlined below.

What are the key FDI drivers that attract MNCs into a country?

This question seeks to establish which FDI determinants are significant for attracting MNCs into a country. Answering this question will assist in achieving the overall aim and specifically objective 2.

What are key political risks that MNC’s consider before investing in a country/region?

This question seeks to establish the key political risk factors MNCs consider before deciding to invest in a country.

How important is political risk in explaining FDI decisions?

This question seeks to determine if there is a positive correlation between political risk and FDI decisions.  Answering this question will assist in achieving objective 4.

How do MNCs manage political risk?

This question attempts to establish how MNCs insulate themselves from political risks, if at all.

1.4: Research Methodology

This dissertation looks at the impact of political risk on FDI decisions by MNCs by conducting documentary research. The documentary research method is used in investigating and categorising physical sources, most commonly written documents, whether in the private or public domain (Payne and Payne 2004). The documents that will be used in this dissertation include: Government publications, surveys and interviews.

1.5:  Significance of the Research

In today’s increasingly globalised world, FDI is a centre for discussion. Numerous studies have been undertaken regarding FDI, its determinants and benefits, but very few works provide importance to the impact of political risk on the inflow of FDI. Previous literature on this subject matter have introduced institutional or governance issues in determining FDI inflow, but comprehensive frameworks in this respect is limited. Therefore, this dissertation intends to contribute to existing research by highlighting the impact of political risk on FDI.

1.6: Dissertation Structure

The rest of this dissertation consists of six chapters. This section summarises the content of each chapter.

Chapter one of this dissertation provides background information in relation to the impact of political risk on FDI decisions by MNCs.  The chapter highlights the motivation for the study and provides the rationale behind the study. The research aim is clearly stated, and specific objectives outlined. Furthermore, the chapter provides the reader with an overview of the research plan and structure.

Chapter two critically reviews relevant literature regarding the macroeconomic determinants of FDI and political risk. Exploring different studies and theoretical constructs pertinent to the research topic is crucial in shaping and validating this study.

Chapter three describes and evaluates in detail the research methods employed in the dissertation and their justification of the issues highlighted in the literature review. It also provides the description of data collection techniques, framework for data analysis and discusses the limitations of the research.

Chapter four is divided into two parts. The first presents the findings from the data. The second provides a thorough analysis and interpretation of the findings, establishing if there are any important links between the findings and literature review.

Chapter five concludes by summarising the main findings from the research and reflects on the extent to which the objectives of the study were achieved. Based on the findings and analysis thereof, report whether the research question was supported or not.

Chapter six contains an analysis and evaluation of the research process, focusing on the assessment of the strengths and weaknesses of the researcher’s learning while undertaking this dissertation.

1.7: summary

Overall, the chapter has addressed the research background, aims and objectives, research questions, methodology and pointed out the outline for the rest of the dissertation. The next chapter presents the literature review.