Profiting from Sanctions: Economic Coercion and US Foreign Direct Investment in Third-Party States

Abstract

Scholarship on the determinants of foreign direct investment (FDI) flows has produced valuable insights into the role of host state characteristics and home-host relations. This study draws attention to another factor in investment decisions-the political and economic relations that home and host states maintain with third-party states. More narrowly, we focus on how investors respond to their home-state's imposition of economic sanctions against a trading partner. Greater economic integration has allowed states to use economic sanctions more frequently in recent decades. At the same time, economic sanctions are thought to have a distorting effect on global trade and financial flows as firms and governments adjust to new constraints. We argue that as firms at home in the sanctioning state respond to coercive measures against a trading partner by looking for alternative sources of profit, they will shift investments to states that can provide indirect access to the sanctioned economy. In particular, those states that are perceived as prospective sanctions-busters-major trading partners of the sanctions target or states with a history of sanctions-busting behavior-will benefit disproportionately from the misfortune of others. We test this conjecture using data on US economic sanctions and global flows of US FDI from 1966 to 2000. The findings reveal that investor decision making in part responds to political developments beyond the home-host dyad.Following the death of anti-apartheid activist Steve Biko in 1977, the US government began to impose economic sanctions on South Africa. These measures, designed to express official US disapproval of apartheid, included a ban on technology exports to South Africa's police and military. Although the sanctions had widespread popular backing, support for them was weaker among US firms with business interests in South Africa. As early as 1978, the US embassy in Pretoria was forced to inform the US State Department that, "multinationals, including US subsidiaries, are determined to undercut any sanctions action and have already made plans to camouflage their operations through subterfuges arranged with

The effect of sanctions on economic freedom

“…We control for the level of democracy in targeted countries using data on polity levels from (Marshall, Gurr, and Jaggers 2016). Foreign direct investment (FDI) has been associated with economic freedom (Bengoa and Sanchez‐Robles 2003) and the use and effectiveness of sanctions (Barry and Kleinberg 2015; Lektzian and Biglaiser 2014). Thus, we control for the level of FDI received by targeted countries using data from The World Bank (2018).…”

Reputation or Interaction: What Drives Cooperation on Economic Sanctions?

“…Yet, cooperation on economic sanctions does occur, and appears to be a systematic feature of international relations (Bapat and Morgan, 2009). Cooperation 4 One could assume that economic sanctions should be modelled as an increase in the costs to the state that has introduced the sanction regime, as business will move on to bust sanctions through, for example, foreign direct investment in third-party states seeking indirect access to the market of the targeted state (Barry and Kleinberg, 2015;Early, 2012). However, the results with asymmetric costs as an outcome of economic sanctions would not change our core findings -the game that states play can be seen as a Prisoners dilemma.…”

The Economic Effects of International Sanctions: An Event Study

“…The limited empirical evidence suggests that sanctions trigger financial crises (Hatipoglu and Peksen 2018;Peksen and Son 2015) and reduce income per capita (Neuenkirch and Neumeier 2015). Reductions in trade (Afesorgbor 2019;Crozet and Hinz 2020;Felbermayr et al 2020b) and foreign direct investment (Biglaiser and Lektzian 2011;Mirkina 2018) are likely transmission channels, but both can be undermined by sanctions busters (Barry and Kleinberg 2015;Early 2015;Haidar 2016Haidar , 2017Lektzian and Biglaiser 2013). The effect of sanctions on the informal economy appears to be ambiguous (Early and Peksen 2019;Farzanegan and Hayo 2019).…”