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Chapter 8

Foreign Direct

Investment

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8-2

What Is FDI?

Foreign direct investment (FDI) occurswhen a firm invests directly in newfacilities to produce and/or market in aforeign countrythe firm becomes a multinational enterprise

FDI can be in the form ofgreenfield investments - the establishment of

a wholly new operation in a foreign countryacquisitions or mergers with existing firms in

the foreign country

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What Is FDI?

The flow of FDI (OVERTIME) - the amountof FDI undertaken over a given time period

Outflows of FDI are the flows of FDI out of acountry

Inflows of FDI are the flows of FDI into acountry

The stock of FDI (SNAPSHOT) - thetotal accumulated value of foreign-

owned assets at a given time

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What Are The Patterns Of FDI?

Both the flow and stock of FDI haveincreased over the last 30 years

Most FDI is still targeted towards developednations

United States, Japan, and the EU

but, other destinations are emerging

South, East, and South East Asiaespecially China

Latin America

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FDI Outflows 1982-2010 ($ billions)

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FDI Inflows by Region 1995-2010 ($ billion)

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The growth of FDI is a result of1. a fear of protectionism want to circumvent trade barriers

2. political and economic changes

deregulation, privatization, fewer restrictions onFDI

3. new bilateral investment treaties designed to facilitate investment

4. the globalization of the world economy many companies now view the world as theirmarket

need to be closer to their customers

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Gross fixed capital formation - the totalamount of capital invested in factories,stores, office buildings, and the like

the greater the capital investment in aneconomy, the more favorable its futureprospects are likely to be

So, FDI is an important source of capitalinvestment and a determinant of the futuregrowth rate of an economy

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Inward FDI as a % of Gross Fixed Capital Formation 1992-2008

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What Is The Source Of FDI?

Since World War II, the U.S. has been thelargest source country for FDI

the United Kingdom, the Netherlands, France,

Germany, and Japan are other importantsource countries

together, these countries account for 60% of

all FDI outflows from 1998-2010

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What Is The Source Of FDI?

Cumulative FDI Outflows 1998-2010 ($ billions)

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Why Do Firms Choose Acquisition

Versus Greenfield Investments?

Most cross-border investment is in theform of mergers and acquisitions ratherthan greenfield investments

between 40-80% of all FDI inflows per annumfrom 1998 to 2009 were in the form ofmergers and acquisitions

but in developing countries two-thirds ofFDI is greenfield investment

fewer target companies

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Why Do Firms Choose Acquisition

Versus Greenfield Investments?

Firms prefer to acquire existing assetsbecausemergers and acquisitions are quicker to

execute than greenfield investmentsit is easier and perhaps less risky for a firm to

acquire desired assets than build them fromthe ground up

firms believe that they can increase theefficiency of an acquired unit by transferringcapital, technology, or management skills

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Why Choose FDI?

Question: Why does FDI occur instead ofexporting or licensing?

1. Exporting - producing goods at home

and then shipping them to the receivingcountry for sale exports can be limited by transportation

costs and trade barriers

FDI may be a response to actual orthreatened trade barriers such as importtariffs or quotas

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Why Choose FDI?

2. Licensing - granting a foreign entity the right toproduce and sell the firms product in return fora royalty fee on every unit that the foreignentity sells

Internalization theory (aka market imperfectionstheory) - compared to FDI licensing is less attractive firm could give away valuable technological know-

how to a potential foreign competitor does not give a firm the control over manufacturing,

marketing, and strategy in the foreign country the firms competitive advantage may be based on

its management, marketing, and manufacturingcapabilities

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What Is The Pattern Of FDI?

Question: Why do firms in the same industryundertake FDI at about the same time and thesame locations?

Knickerbocker - FDI flows are a reflection ofstrategic rivalry between firms in the globalmarketplacemultipoint competition -when two or more enterprises

encounter each other in different regional markets,

national markets, or industries

Vernon - firms undertake FDI at particular stagesin the life cycle ofa product

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What Is The Pattern Of FDI?

Question: But, why is it profitable for firms toundertake FDI rather than continuing to exportfrom home base, or licensing a foreign firm?

Dunnings eclectic paradigm- it is important to

consider location-specific advantages - that arise from using

resource endowments or assets that are tied to aparticular location and that a firm finds valuable tocombine with its own unique assets

externalities - knowledge spillovers that occur whencompanies in the same industry locate in the samearea

Wh A Th Th i l

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What Are The Theoretical

Approaches To FDI?

The radical view - the MNE is an instrument ofimperialist domination and a tool for exploitinghost countries to the exclusive benefit of theircapitalist-imperialist home countries in retreat almost everywhere

The free market view- international productionshould be distributed among countries accordingto the theory of comparative advantageembraced by advanced and developing nations

including the United States and Britain, but no countryhas adopted it in its purest form

Wh A Th Th i l

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What Are The Theoretical

Approaches To FDI?Pragmatic nationalism - FDI has both

benefits (inflows of capital, technology, skillsand jobs) and costs (repatriation of profits tothe home country and a negative balance of

payments effect)FDI should be allowed only if the benefits outweigh

the costs

Recently, there has been a strong shift towardthe free market stance creatinga surge in FDI worldwidean increase in the volume of FDI in countries with

newly liberalized regimes

H D FDI B fi

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How Does FDI Benefit

The Host Country?

There are four main benefits of inwardFDI for a host country

1. Resource transfer effects - FDI bringscapital, technology, and managementresources

2. Employment effects - FDI can bring jobs

H D FDI B fit

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The Host Country?

3. Balance of payments effects - FDI can help acountry to achieve a current account surplus

4. Effects on competition and economic growth -

greenfield investments increase the level ofcompetition in a market, driving down pricesand improving the welfare of consumers

can lead to increased productivity growth, product

and process innovation, and greater economicgrowth

Wh t A Th C t Of

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What Are The Costs Of

FDI To The Host Country?

Inward FDI has three main costs:

1. Adverse effects of FDI on competitionwithin the host nation

subsidiaries of foreign MNEs may havegreater economic power than indigenouscompetitors because they may be part of a

larger international organization

Wh t A Th C t Of

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FDI To The Host Country?

2. Adverse effects on the balance of payments

when a foreign subsidiary imports a substantialnumber of its inputs from abroad, there is a debit onthe current account of the host countrys balance of

payments

3. Perceived loss of national sovereignty andautonomy

decisions that affect the host country will be madeby a foreign parent that has no real commitment tothe host country, and over which the host countrys

government has no real control

H D FDI B fit

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The Home Country?

The benefits of FDI for the home countryinclude

1. The effect on the capital account of the home

countrys balance of payments from the inwardflow of foreign earnings

2. The employment effects that arise fromoutward FDI

3. The gains from learning valuable skills fromforeign markets that can subsequently betransferred back to the home country

Wh t A Th C t Of

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FDI To The Home Country?

1. The home countrys balance of paymentscan suffer

from the initial capital outflow required to

finance the FDI

if the purpose of the FDI is to serve the homemarket from a low cost labor location

if the FDI is a substitute for direct exports

Wh t A Th C t Of

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FDI To The Home Country?

2. Employment may also be negatively affected ifthe FDI is a substitute for domestic production

But, international trade theory suggests that

home country concerns about the negativeeconomic effects ofoffshore production (FDIundertaken to serve the home market) may notbe valid may stimulate economic growth and employment in

the home country by freeing resources to specializein activities where the home country has acomparative advantage

H D G t

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How Does Government

Influence FDI?

Governments can encourage outward FDI

government-backed insurance programs tocover major types of foreign investment risk

Governments can restrict outward FDI

limit capital outflows, manipulate tax rules, oroutright prohibit FDI

H D G t

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How Does Government

Influence FDI?

Governments can encourage inward FDI

offer incentives to foreign firms to invest intheir countries

gain from the resource-transfer and employmenteffects of FDI, and capture FDI away from otherpotential host countries

Governments can restrict inward FDI

use ownership restraints and performancerequirements

How Do International

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How Do International

Institutions Influence FDI?

Until the 1990s, there was no consistentinvolvement by multinational institutions inthe governing of FDI

Today, the World Trade Organization ischanging this by trying to establish auniversal set of rules designed to promote

the liberalization of FDI

What Does FDI

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What Does FDI

Mean For Managers?

Managers need to consider what tradetheory implies about FDI, and the linkbetween government policy and FDI

The direction of FDI can be explainedthrough the location-specific advantagesargument associated with John Dunning

however, it does not explain why FDI ispreferable to exporting or licensing, mustconsider internalization theory

What Does FDI

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What Does FDI

Mean For Managers?A Decision Framework

What Does FDI

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What Does FDI

Mean For Managers?

A host governments attitude toward FDI is

important in decisions about where tolocate foreign production facilities and

where to make a foreign direct investmentfirms have the most bargaining power when

the host government values what the firm has

to offer, when the firm has multiplecomparable alternatives, and when the firmhas a long time to complete negotiations

2000 chp 8 fdi

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