Chapter 8 Foreign Direct Investment What Is FDI

Chapter 8 Foreign Direct Investment

What Is FDI? Ø Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country Ø the firm becomes a multinational enterprise Ø FDI can be in the form of Ø greenfield investments - the establishment of a wholly new operation in a foreign country Ø acquisitions or mergers with existing firms in the foreign country Ø Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments 8 -2

Why Do Firms Choose Acquisition Versus Greenfield Investments? Ø Firms prefer to acquire existing assets because Ømergers and acquisitions are quicker to execute than greenfield investments Øit is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up Øfirms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills 8 -3

What Are The Patterns Of FDI? Ø The flow of FDI - the amount of FDI undertaken over a given time period Øoutflows of FDI are the flows of FDI out of a country Øinflows of FDI are the flows of FDI into a country Ø The stock of FDI - the total accumulated value of foreign-owned assets at a given time Ø Both the flow and stock of FDI have increased over the last 30 years 8 -4

What Are The Patterns Of FDI? Ø The growth of FDI is a result of 1. A fear of protectionism Ø want to circumvent trade barriers 2. Political and economic changes Ø deregulation, privatization, fewer restrictions on FDI 3. New bilateral investment treaties Ø designed to facilitate investment 4. The globalization of the world economy Ø many companies now view the world as their market Ø need to be closer to their customers 8 -5

Why Choose FDI? Ø 1. 2. Question: Why choose FDI not exporting or licensing? Exporting - producing goods at home and then shipping them to the receiving country for sale Licensing - granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells Ø Ø Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace Ø Ø internalization theory (aka market imperfections theory) multipoint competition Vernon - firms undertake FDI at particular stages in the life cycle of a product 8 -6

Why Choose FDI? Ø Dunning’s eclectic paradigm - it is important to consider Ølocation-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets Øexternalities - knowledge spillovers that occur when companies in the same industry locate in the same area 8 -7

What Are Theoretical Approaches To FDI? Ø The radical view - the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries Ø The free market view - international production should be distributed among countries according to theory of comparative advantage Ø Pragmatic nationalism - FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect) 8 -8

What Does FDI Mean For The Host Country? Ø Benefits of inward FDI for a host country 1. 2. 3. 4. Resource transfer effects Employment effects Balance of payments effects Effects on competition and economic growth Ø Costs of inward FDI for a host country 1. Adverse effects on competition within the host nation 2. Adverse effects on the balance of payments 3. Perceived loss of national sovereignty and autonomy 8 -9

What Does FDI Mean For The Home Country? Ø Benefits of FDI for the home country include 1. The positive effect on the capital account from the inward flow of foreign earnings 2. The employment effects that arise from outward FDI 3. The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country Ø Costs of FDI for the home country include 1. The negative effect on the balance of payments 2. Employment may also be negatively affected if the FDI is a substitute for domestic production 8 -10

How Does Government Influence FDI? Ø Governments can encourage outward FDI Ø government-backed insurance programs to cover major types of foreign investment risk Ø Governments can restrict outward FDI Ø limit capital outflows, manipulate tax rules, or outright prohibit FDI Ø Governments can encourage inward FDI Ø offer incentives to foreign firms to invest in their countries Ø Governments can restrict inward FDI Ø use ownership restraints and performance requirements 8 -11

What Does FDI Mean For Managers? Ø Managers need to consider what trade theory implies about FDI, and the link between government policy and FDI Ø The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning Ø A host government’s attitude toward FDI is an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment 8 -12