Foreign Direct Investment

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• Foreign Direct Investment

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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?

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Foreign Direct Investment

• Foreign direct investment (FDI) a firm invests
  directly in foreign facilities
• A 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

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Foreign Direct Investment

• Involves ownership of entity abroad for
• production
• Marketing/service
• RD
• 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

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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 gt 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

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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

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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
• New investment why? why not?
• No local entity is available for sale, local
  financial incentives, no inherited problems, long
  lead time to generation of sales
• International joint-venture
• Shared ownership with local and/or other
  non-local partner
• Shared risk

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Alternative Modes of Market Entry

• FDI
• FDI - 100 ownership
• FDI lt 100 ownership, International Joint Venture
• Strategic Alliances (non-equity)
• Franchising
• Licensing
• Exports Direct vs Indirect

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Why FDI?

• FDI over exporting
• High transportation costs, trade barriers
• FDI over licensing or franchising
• Need to retain strategic control
• Need to protect technological know-how
• Capabilities not suitable for licensing/franchisin
  g
• Follow few main competitors
• Immediate strategic responses

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Pattern of FDI Explanations

• International product life-cycle (Ray Vernon)
• Trade theory similarity
• Eclectic 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

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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

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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

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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
• Threat to national sovereignty and autonomy
• Loss of economic independence

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Government Policy and FDI

• Home country
• Outward FDI encouragement
• Risk reduction policies (financing, insurance,
  tax incentives)
• Outward FDI restrictions
• National security, BOP
• Host country
• Inward FDI encouragement
• Investment incentives
• Job creation incentives
• Inward FDI restrictions
• Ownership extent restrictions (national security
  local nationals can safeguard host countrys
  interests

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Decision Framework for FDI
Import Barriers?
No
No
Export
Yes
No
FDI
Yes
FDI
Yes
FDI
No
License
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