Foreign Direct Investments

Introduction
• Exports are just one way that firms can place
their products in foreign markets, a process
known as foreign market entry
• Two other means are
– Contracting
– Foreign direct investment
• Contracting and foreign direct investment are
two types of international production
• These are described in Table 9.1
 Table 9.1: The Foreign Market Entry Menu
Category Mode Characteristics
Domestic None Purely domestic firm supplying home market
Exporting Indirect Exporting Another firm acts as sales agent
Exporting Direct Exporting Firm completes export transaction itself
Contractual Licensing License to foreign firm to produce abroad
Contractual Franchising License with conditions to ensure consistency
Contractual Subcontracting Contract with materials and specifications
Investment Joint Venture Jointly owned separate firm
Investment Mergers and Purchase of part or whole of foreign firm
Acquisitions
Investment Greenfield Brand-new production facility
 Exporting
• Indirect exporting
– The home-country firm relies on another firm
known as a sales agent or trading company to
complete the export transaction
• Direct exporting
– The home-country firm takes on the export
transaction itself
– This can include the research, marketing, finance,
and logistics requirements of the trade trasaction
 Contractual
• Licensing
– The home-country firm licenses a foreign firm to allow it to use
the home-country firm’s production process in the foreign
country
• Franchising
– The home-country firm licenses a foreign firm to allow it to use
the home-country firm’s production process in the foreign
country but exerts more control over production and marketing
to ensure consistency across foreign markets
• Subcontracting
– The home-country firm contracts with a foreign firm to produce
a product to certain specifications
 Investment
• Joint venture (JV)
– The home-country firm establishes a separate firm in the foreign
country that is jointly-owned with a foreign-country firm
• Mergers and acquisitions (M&A)
– The home-country firm buys part (merger) or all (acquisition) of
the shares of an already-existing production facility in the
foreign country
• Greenfield investment
– The home-country firm establishes a brand-new production
facility in the foreign country that it fully owns
 Motivation for International Production
• Resource seeking
– Gaining access to natural resources or human resources
• Market seeking
– Locating near expected market growth, to better adapt a
product to local needs, and to supply intermediate inputs to
another firm
• Efficiency seeking
– Rationalize the established structure of international production
for economies of scale and scope
• Strategic asset seeking
– Part of a strategic game among global competitors in
oligopolistic sectors
 Strategic Asset Seeking
• Insights from Dunning and Lundan (2008)
– Acquiring or collaborating with another to thwart a competitor from
doing so
– Merging with a foreign rivals to strengthen joint capabilities
– Acquiring a group of suppliers to corner the market for a particular
raw material
– Gaining access over distribution outlets to better promote its own
brand of products
– Buying out a firm producing a complementary range of goods or
services so it can offer its customers a more diversified range of
products
– Joining forces with a local firm in the belief that it is in a better
position to secure contracts from the host government
 Entry Mode Choice
• Economic view
– A firm will chose the entry mode that will provide it with the
greatest risk-adjusted or expected return on the entry
investment
• Entry mode choice factors include
– Degree of control
– Level of resource commitment
– Dissemination risk
• Dissemination risk
– the possibility of a foreign partner firm obtaining technology or
other know-how from the home-country firm and exploiting it
for its own commercial advantage
 Table 9.2: Factors Influencing Choice of Foreign
Market Entry Mode

Mode Degree of Control Level of resource Degree of

commitment dissemination
risk
Trade Low Low Low
Contractual Low Low High
Investment- Joint Medium Medium Medium
Venture
Investment- M&A High High Low
or greenfield

Source: Hill, Hwang and Kim (1990)

 Entry Mode Choice
• If a firm’s most important concern was
– Degree of control over the production and marketing
process
• Lead the firm towards an investment mode of foreign market entry
based on a subsidiary obtained either through greenfield or
acquisition investment
– Limiting resource commitment to low levels
• Consider either trade or contractual modes of foreign market
entry
– Low degree of dissemination risk
• Either trade or investment via a subsidiary would be the preferred
mode of entry
• In most instances, firms have more than one primary
concern
 The Rise of Multinational Enterprises and
International Production
• Early MNEs were part of the colonization efforts during
the 16th and 17th centuries
– Included state-supported trading companies such as the British East
India Company, the Dutch East India Company, and the Royal African
Company
– Known as the age of merchant capitalism
• Industrial revolution in the 19th century led to industrial
capitalism
– British-based MNEs operating in India, China, Latin America, and South
Africa
• Involved in mining, plantation agriculture, finance, and shipping
– Japan became involved in MNE activity after the Meiji Restoration
 The Rise of Multinational Enterprises and
International Production
• In the 20th century, industrial production grew more
capital intensive
– Role of the production line and associated economies of scale
grew more important
• Era of industrial capitalism gave way to managerial
capitalism or Fordism
– Center of innovative economic activity moved from Europe to
the United States
– Firm size increased
– Business success became based on the ability to coordinate
growing sets of complementary activities
 The Rise of Multinational Enterprises and
International Production
• Depression that began in 1929 and the Second World
War hurt most forms of international economic activity
• Post-war recovery further strengthened the role of US-
based MNEs
– Technological advantage of US-based MNEs during the early
post-war period was the point of reference of the product life
cycle theory
• Production is confined to the home base MNE during the early
phases of product life cycle
• During later phases production can move to subsidiaries in foreign
countries in order to take advantage of lower labor costs
 The Rise of Multinational Enterprises and
International Production
• The 1970s had the rise of industrial output in the newly
industrializing countries (NICs) of East Asia
– Especially Japan, Taiwan, and South Korea
– Many see this as new economic era known as post-Fordism or
Toyotism
– Economies of scale have been replaced by flexibility as the progressive
element in manufacturing and the use of information and
communication technology (ICT) to control production processes
• Rise of industrial output was followed by a rise in FDI on the
part of East-Asian based MNEs
– Especially those based in Japan
 Migration

An Introduction to International
Economics: New Perspectives on the
World Economy
 Analytical Elements
• Countries
• Firms
• Factors of production
 Types of Migration
• Beath, Goldin and Reinert (2009) distinguished among nine
different types of international migration
• Permanent high-skilled migration
– Involves permanent residence and is sometimes granted to high-
skilled migrants often at the urging of hiring corporations such as the
multinational enterprises (MNEs)
• Temporary high-skilled migration
– Similar in motivation to permanent high-skilled migration but can be
more politically palatable in some cases where there is political
resistance to granting permanent residence
• Temporary low-skilled migration
– Includes migrant workers in the areas of manual labor, construction,
domestic service and nursing
 Types of Migration
• Family migration
– A large flow that allows permanent residence to the families of those
who have already gained this residence
• Coethnic and national priority migration
– Involves granting permanent residence based on ethnic background,
religious affiliation and national origin
• Asylum seekers
– Granted certain rights by the 1951 Geneva Convention addressing
persons with well-founded fears of persecution
• Refugees
– Those who flee to neighboring countries to escape war, famine or
environmental catastrophes
 Types of Migration
• Undocumented migration
– A large category that involves both voluntary and non-voluntary
(trafficked) illegal migrants
• Visa-free migration
– Exists in some common markets (e.g., the EU) that involve the free
movement of both labor and capital
• While all of these types of migration are important, in this
chapter, we will focus on high-skilled and low-skilled migration
 Migration into the European Union

Source: www.guardian.co.uk
Migration Factors
Figure 12.1: The Migration Decision
 Migration Factors
• Financial resources
– Given the direct and opportunity costs of migration, as GDP per capita
rises, the supply curve in Figure 12.1 shift to the right
• Education levels
– Increasing education levels increases the information and aspiration of
Moroccans to migrate, shifting the supply curve in Figure 12.1 to the
right
• Migration networks
– Networks of migrants in the EU are conduits of information back to
potential migrants in Morocco
– As these networks develop, the supply curve in Figure 12.1 shifts to
the right
 The Emigration Supply Curve
• Historical evidence suggests that shifts of the ES curve in
Figure 12.1 can be more significant than movements along
the curve
• Additionally, the four shift factors can work together as origin
countries develop
• The approximate correlation of all four shift factors in time
can lead to a phenomenon known as the migration hump
shown in Figure 12.2
• The migration hump indicates that
– Barring political or ecological impetus, most international migration is
from middle-income countries
– The migration flows that occur near the peak of the migration hump
can persist for some time
Figure 12.2: A Highly-Stylized “Migration
Hump”
 High-Skilled Migration
• Data on high-skilled migration (HSM) are both scarce and
unreliable, but nevertheless some patterns are discernible
• HSM has been on an upward trend for some time now
• The increase in demand for HSM appears to be related to
skills-biased technological change in high-income destination
countries that is related to the information and
communication technology (ICT)
• The types of firms who hire HSM tend to be larger firms that
are more internationalized via foreign ownership and exports
 High-Skilled Migration
• Firms active in HSM face volatile policy regimes in terms
of visa requirements and quotas
• HSM can contribute to what is known as brain drain
– The loss of human capital in low-income source countries due to
the migration of citizens to foreign destination countries
– This is of particular concern in the health sector
• More positively, return migration back to home countries
has begun, and these new flows can transfer technology
and entrepreneurial skills back to the origin countries
 High-Skilled Migration
• It is possible that the phenomenon of brain drain can
evolve into brain circulation
– Expatriates from developing countries return either temporarily
or permanently to contribute to what might be called
intellectual remittances
• These return migrants can even have a subsequent,
positive effect on inflows of FDI
– The return migration and subsequent enterprise development
act as a signal to foreign MNEs that conditions are ripe for FDI
by enhancing the location advantages
 Low-Skilled Migration
• The supply-side of low-skilled migration (LSM) can be roughly
described using our discussion of Figure 12.1
• There is also the demand side to consider
– A number of key destination countries are experiencing a “birth
dearth” or a decline in populations due to low fertility rates
– The persistence of low-skilled, non-tradable services in destination
countries
• These two demand-side factors cause the demand curve for
LSM to shift to the right as in Figure 12.3
• This graph is drawn, the relative unskilled wage remains the
same, but it could either increase or decrease
Figure 12.3: The Market for Low-Skilled
Migration
 Low-Skilled Migration
• LSM is much more likely than HSM to also fall into the
categories of refugees and undocumented migration
• The illegal nature of much LSM makes it politically
volatile but also economically attractive to firms hiring
them since the workers have no bargaining power
• Illegality also makes the migrants open to exploitation
and abuse
 Remittances
• Remittances are flows of money from emigrants to their
countries of origin
• Data on remittance flows going back to 1970 are presented in
Figure 12.4
– Remittance flows have increased dramatically since the mid-1990s
– Most of the increase in remittances has been to middle income
countries
• Remittances can have significant and positive impacts in
developing countries by directly transferring income more
efficiently than foreign aid
 billions US$

0
100
200
300
400
500
600
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986

Low income
1987
1988
1989
1990
1991
1992

Middle income
1993
1994
1995
World Bank)

1996
1997
High income 1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Figure 12.4: Remittances, 1970-2013 (Source:

2012
2013
 Migration Policy
• Unlike in the realms of international trade (the World Trade
Organization), international finance (the International
Monetary Fund), and international development (the World
Bank), there is no multilateral organization for migration
policy
• In most cases, the policy locus of international migration
policy is the nation state based on the principle of sovereignty
• In contrast to the “pro-market” orientations of policy regimes
in trade, finance and development policy, intervention and
coercion are the order of the day in migration policy
 Migration Policy
• Some observers have suggested that such a multilateral
organization would be a good idea
• Others have emphasized that, given political realities,
migration policy advances can best be achieved bilaterally
• This does not rule out the pursuit of limited, basic principles
at the multilateral level
– The International Organization for Migration (IOM) oversees an
International Dialogue on Migration
– This is “an opportunity for governments, inter-governmental and non-
governmental organizations and other stakeholders to discuss
migration policy issues, in order to explore and study policy issues of
common interest and cooperate in addressing them.”