Foreign Direct Investment

Foreign Direct Investment

Why is FDI increasing in the world economy? Why do firms often prefer FDI to other market entry strategies? Why do firms imitate competitors with FDI strategies? Why are certain locations favored for FDI? How does political ideology affect government FDI policy? What are key FDI related costs and benefits for receiving and source countries?

Foreign Direct Investment

Foreign

direct investment (FDI): a firm invests directly in foreign facilities firm that engages in FDI becomes a multinational enterprise (MNE)
Multinational = more than one country

Factors

which influence FDI are related to factors that stimulate trade

Foreign Direct Investment

Involves ownership of entity abroad for

production

Marketing/service
R&D Access of raw materials or other resource

Parent has direct managerial control

Depending on its extent of ownership and On other contractual terms of the FDI

No managerial involvement = portfolio investment

FDI Growth in the World Economy

FDI Outflow: $35 billion in 75 to $1.3 trillion in 00 to $653 billion in 03 FDI Flow (from all countries): from 92 to 02 up 292%, compared to trade up 69% and world output up 28% FDI Stock: $3.5 trillion by 97 to > $7 trillion in 02 In 02:

64,000 MNEs had: 850,000 foreign affiliates 53 million employees $17.7 trillion in sales $8 trillions global exports

Conclusion: FDI flow growing faster than world trade and world output

Direction and Source of FDI

Most

FDI flow has been to developed countries from developed countries

Much to the US from EU, Japan

FDI

increase to developing countries since

85
Much to the emerging Asian and Latin

America economies
Africa lagging

Forms of FDI

FDI forms
Purchase of assets: why? why not?

Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems No local entity is available for sale, local financial incentives, no inherited problems, long lead time to generation of sales

New investment: why? why not?

International joint-venture

Shared ownership with local and/or other non-local partner Shared risk

Alternative Modes of Market Entry

FDI
FDI - 100% ownership FDI < 100% ownership, International Joint

Venture
Strategic

Alliances (non-equity)

Franchising
Licensing Exports:

Direct vs Indirect

Why FDI?
FDI
FDI

over exporting
over licensing or franchising

High transportation costs, trade barriers

Need to retain strategic control Need to protect technological know-how Capabilities not suitable for licensing/franchising
Follow

few main competitors

Immediate strategic responses

Pattern of FDI Explanations

International product Eclectic

life-cycle (Ray Vernon)

Trade theory similarity

paradigm of FDI (John Dunning)

Combines ownership specific, location specific,

and internalization specific advantages

Explains FDI decision over a decision to enter

through licensing or exports

Eclectic Paradigm of FDI (Dunning)

Ownership advantage: creates a monopolistic advantage to be used in markets abroad

Unique ownership advantage protected through ownership
e.g., Brand, technology, economies of scale, management know-how

Location advantage: the FDI destination market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) that are advantageous for the firm to locate its investment there (link to trade theory) Internalization advantage: transaction costs of an arms-length relationship --licensing, exports-- higher than managing the activity within the MNCs boundaries

Government Policy and FDI

The radical view: inbound FDI harmful; MNEs Are imperialist dominators Exploit host to the advantage of home country Extract profits from host country; give nothing back Keep LDCs backward and dependent for investment, technology and jobs The free market view: FDI should be encouraged Adam Smith, Ricardo, et al: international production should be distributed per national comparative advantage An MNE increases the world economy efficiency

Brings to bear unique ownership advantages Adds to local economys comparative advantages

Host Country Effects of FDI

Benefits

Resource -transfer Employment Balance-of-payment (BOP)

Import substitution Source of export increase

Costs

Adverse effects on the BOP

Capital inflow followed by capital outflow + profits Production input importation Loss of economic independence

Threat to national sovereignty and autonomy

Government Policy and FDI

Home

country
Risk reduction policies (financing, insurance, tax incentives) National security, BOP

Outward FDI encouragement Outward FDI restrictions

Host

country
Investment incentives Job creation incentives Ownership extent restrictions (national security; local nationals can safeguard host countrys interests

Inward FDI encouragement

Inward FDI restrictions

Decision Framework for FDI

Are transportation costs high?
Ye s

No

Import Barriers?
Ye s

No

Export

Is know-how easy to license?

Ye s

No

FDI

Tight control over foreign ops required?

No

Yes

FDI

Is know-how valuable and is protection possible?

Yes No

FDI

License