EAI Asia Security Initiative Working Paper No. 13

Author

Dong-Hun Kim is an Assistant Professor of Political Science at Korea University. His current research interests include politics of non-tariff barriers, anti-trust and competition policies, and foreign investments. He received his BA and MA from Korea University, and PhD from the University of Iowa. Professor Kim has previously taught at Oakland University (2006-2009). His recent publications include articles in journals such as Comparative Political Studies, State Politics & Policy Quarterly, Public Procurement Law Review, Public Choice, Kyklos, the World Economy, Journal of Peace Research, and Journal of Conflict Resolution. 

I. Introduction

Since the 1980s China has steadily increased its foreign direct investments (FDIs) in African nations for various reasons. Not only has China overtaken the World Bank in lending to Africa, but also Chinese firms have heavily invested in various sectors and nearly 800 Chinese companies now operate in that continent (Foerstel 2009). For instance, in 1998, China began a 957-mile-long oil pipeline project in Sudan, the largest foreign project in China's history. It sent 7,000 workers to Sudan, along with multi-billion investments in infrastructure projects for other natural resources such as gold mines (Lee 2007). Africa's business opportunities and natural resources, however, prompted other countries to work to catch up. As EU spokesperson Amadeu Altafaj Tardui once said, "Most African countries are smart enough to diversify portfolios.

We don't fear a Chinese monopoly." The competition indeed heated up as foreign investments from European Union countries and the United States started to increase (Foerstel 2009). In the meantime, the Western coun-tries were concerned with human rights abuses in Africa, especially in Sudan, where more than 200,000 people have died in Darfur since 2003, and attempted to impose economic sanctions to demand that the Sudanese government halt the genocide. China, however, has been reluctant to leverage its investments to correct the Sudanese government and has repeatedly blocked the United Nation's efforts to impose sanctions against Sudan. The reason why China would not join sanction efforts seems obvious: its foreign investment in oil. Yet the puzzle remains. Do foreign investments deter the use of sanctions in general? Do all types of foreign investment have similar consequences? This paper examines the relationship between foreign direct investment and the use of economic sanctions.

The use of economic policy instruments to coerce other states has been a prominent tool of statecraft for thousands of years. It is well known that this method goes as far back as 432 B.C., when Athens used it against the state of Megara (Tsebelis 1990). Since the 1990s, however, the popularity of economic statecraft, defined as the use of economic policy in-struments to achieve the goals of nation-states (Baldwin 1985), has been increasing. The threat of economic sanctions as well as the actual use of them has increased more than 20 percent over previous decades (Drezner 2003). It is no coincidence that the heightened at-tractiveness of economic coercion as a policy tool has grown along with increased economic ties in the era of globalization. It is the economic relationship that creates the direct eco-nomic leverage and makes economic coercion possible. Furthermore, it is possible that in-creased economic ties will create more means and greater opportunities for sanctions (Cox and Drury 2006; Hafner-Burton and Montgomery 2008). At the same time, increased eco-nomic ties limit a state's willingness to engage in military conflict and force foreign policy-makers to resort to less costly actions such as economic statecraft if friction occurs (Drury 2001). Consequently, sanctions have never been as popular among foreign policymakers as they are today (Kirshner 2002).

The popularity of sanction, not surprisingly, has brought increased scholarly attention to it, and the sanction debate, the question of whether or not sanction works, has become one of the heated controversies in the literature (For example, Pape 1997; Elliott 1998; Drezner 1999; Hovi, Huseby, and Sprinz 2005; Hufbauer et al. 2007). Following recent at-tempts to increase our understanding of various aspects of economic sanctions (for exam-ple, Dorussen and Mo 2001; Lektzian and Souva 2003; Lektzian and Sprecher 2007; Haftner-Burton and Montgomery 2008; Bapat and Morgan 2009; Peksen and Drury 2010; McLean and Whang 2010), this paper pays attention to an aspect of economic statecraft that was neglected in previous literatures. In particular, there are few, if any, studies on the impact of the new forms of economic interdependence such as various types of foreign direct investments on economic statecraft. This is critical, since we are experiencing rapid changes in the global economy. States are increasingly tied to each other through different forms of exchange relations as evident by the explosive growth in foreign direct investments and international capital markets. As Figure 1 displays, the size of FDI grew exponentially over the last three decades, and the volume of international production by FDI exceeded that by trade in the mid-1980s. In addition, the forms of foreign investment have been rapidly changing. Cross-border mergers and acquisitions (M&As) and cross-border corporate alliances have become prominent components of foreign investment during the past few decades (Conybeare and Kim 2010). It is not an exaggeration to say that the main characteristics of the global economy have been fundamentally changed (Strange 1996; UNCTAD 2000). Unfortunately, however, there exists little research examining the impacts and implications of these changes for foreign policy (Schneider, Barbieri, and Gleditsch 2003). What are the implications of various foreign investments on economic statecraft? Do these changes make sanctions more likely? This paper addresses this important gap in the literature by examining the impact of specific types of foreign investment, in particular, cross-border M&As and cross-border corporate alliances on the use of economic sanctions.

Figure: Inward FDI flows, 1970-2006 (millions of US dollars)

Source: UNCTAD (2009)

II. Varieties of Foreign Direct Investments

During the past two decades, the globalization of production through foreign direct invest-ment (FDI) has grown to characterize international economic ties. Global FDI inflows reached a historic high of $1,979 billion in 2007 after achieving more than a 30 percent growth rate annually from 1986 (UNCTAD 2009). A notable feature is the fact that not only developed countries but also other major groups of economies such as developing countries, transition economies, and least developing countries saw continued growth in FDI. Additionally, in terms of geography, almost no region, including Africa, has been left out of this trend (UNCTAD 2009).Without a doubt, these trends have changed how countries are linked in economic terms. The importance of FDI can be better recognized if one examines the indicators of international production. In 2007, the number of multinational corporations (MNCs) reached 79,000, and these control some 790,000 foreign affiliates around the world, whose activities account for about 11 percent of the global GDP, employing more than 80 million people (UNCTAD 2009).

In addition, foreign affiliates of MNCs account for about a third of the total world ex-port of goods and services (UNCTAD 2009).While the earlier theoretical works such as Mundell (1957) suggested that trade (product movement) and foreign direct investment (factor movement) are substitutes rather than complements, recent empirical and theoret-ical investigations indeed support the opposite—a complementary relationship between FDI and trade (Helpman 1984; Blonigen 2001). For example, according to Bernard, Jensen, and Schott (2007), 90 percent of U.S. trade flows via U.S. multinational corporations, with about 50 percent between affiliates of the same multinational corporations. Not only does FDI establish a larger distribution base and stimulate sales in a foreign market, but also the FDI creates local production that requires inputs to be imported and also exports in-termediate goods to the home and other regions. Note that this complementarity between FDI and trade is mainly the result of the growing fragmentation of production, that is, the division of the production process into two or more steps that can be undertaken in dif-ferent locations, and the trade-boosting effects of FDI do not just occur in the bilateral relationship. Indeed, as Brooks (2005) has argued, it no longer makes sense to focus on the security implications of trade. The activities of multinational corporations, FDI and the globalization of production, are now the key integrating forces in the international economic transaction. It is an international production via FDI that characterizes the economic interdependence among states rather than mere exports and imports.

FDI, however, does not entail a singular form. Firms do not invest abroad only by a few means. They have to make strategic decisions when they start foreign operations. Firms can acquire an existing company or set up a new venture and also must decide the level of con-trol of their foreign affiliates. An FDI could entail a form of joint venture /corporate alliance by forming partnerships with local firms or be greenfield investments or cross-border M&As with full ownership. Corporate alliances or joint ventures (JVs) occur when two or more firms pool a portion of their assets in a common and separate legal organization (Conybeare and Kim 2010). There are two general reasons why JVs are often preferred as the entry mode. First, JVs offer benefits especially such as allowing FDI to limit the initial risk and gain the flexibility that later enables them to terminate the investment depending on the performance with lower costs than other entry modes (for example, M&As).

Second, JVs create mutual hostage positions between FDI and the host. Through the joint commit-ment of financial or physical assets, JVs can provide the incentive for the host to care more (Reuer 2004). Not surprisingly, the number of JVs has dramatically increased in the past two decades. Since 1990, on average, more than 6,400 JVs were announced annually world-wide and more than 4,500 deals were completed annually (Conybeare and Kim 2010).The share of cross-border JVs also increased altogether. About 58 percent of all completed JVs are cross-border JVs that include more than one firm from another country (Conybeare and Kim 2010). For example, as Figure 2 displays, the number of completed cross-border JVs by U.S. firms increased dramatically after the 1990s...(Continued)