Foreign Direct Investment 8 1 Foreign Direct Investment

Foreign Direct Investment 8 -1

Foreign Direct Investment • FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country. – Once a firm undertakes FDI, it becomes a multinational enterprise (multinational = more than one country). 8 -2

FDI takes two forms • Greed-field investment: establishing a wholly new operation in a foreign country. – Mostly in developing nations • Acquiring or merging with an existing firm in the foreign country. – Quicker to execute – Foreign firms have valuable strategic assets – Believe they can increase the efficiency of the acquired firm – More prevalent in developed nations • Investing in foreign financial instruments (Portfolio Investment) IS NOT FDI. 8 -3

Trends in FDI • Flow and stock increased in the last 20 years • In spite of decline of trade barriers, FDI has grown more rapidly than world trade because – – – Businesses fear protectionist pressures FDI is seen a a way of circumventing trade barriers Dramatic political and economic changes in many parts of the world – Globalization of the world economy has raised the vision of firms who now see the entire world as their market 8 -4

Slumping FDI • Between 2000 and 2004 the value of FDI slumped almost 50% from $1. 2 trillion to about $620 billion • The slowdown in FDI flows has been most pronounced in developed nations • The slowdown is probably temporary and reflects three developments – General slowdown in the growth rate of the world economy – Heightened geopolitical uncertainty following the September 11, 2001 attack 8 -5

FDI Outflows 8 -6

The Direction of FDI • Historically, most FDI has been directed at the developed nations of the world as firms based in advanced countries invested in other markets – The US has been the favorite target for FDI inflows • While developed nations still account for the largest share of FDI inflows, FDI into developing nations has increased – Most recent inflows into developing nations have been targeted at the emerging economies of South, East, and Southeast Asia 8 -7

FDI Flow by Region 8 -8

Worldwide FDI Flows World FDI inflows è Developed (70%), developing (30%) è European Union: ~ 50% of world FDI 64, 000 multinationals Developing nations è China: 8% of world FDI è All of Africa: 2% of world FDI with 870, 000 affiliates 8 -9

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The Shift to Services • The shift to services is being driven by four factors – Reflects the general move in many developed economies away from manufacturing and toward service industries – Many services cannot be traded internationally – Many countries have liberalized their regimes governing FDI in services – The rise of Internet-based global telecommunications networks has allowed some service enterprises to relocate some of their value creation activities to different nations to take advantage of favorable factor costs 8 -13

Reasons for FDI Growth Increasing globalization International mergers and acquisitions Entrepreneurship and small firms 8 -14

EXPLAINATIONS FOR FDI Market Imperfections (Internalization) • Market imperfections are factors that inhibit markets from working perfectly – In the international business literature, the marketing imperfection approach to FDI is typically referred to as internalization theory • Company undertakes FDI to internalize a transaction that is being made inefficient by a market imperfection Ø Trade barriers Ø (e. g. , tariffs) Ø Specialized knowledge Ø (e. g. , managerial ability) 8 -15

International Product Life Cycle A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle 8 -16

Eclectic Theory A firm undertakes FDI when location, ownership and internalization advantages combine to make a location appealing Location advantage Ownership advantage Internalization advantage (optimal location) (special asset) (efficiency) 8 -17

Market Power A firm undertakes FDI to establish a dominant presence in an industry Market power = Greater profits Vertical integration Extends company’s activities into stages of production that provide its inputs (backward integration) or absorb its outputs (forward integration) 8 -18

Pursuit Of Global Strategies - Easily to coordinate the participation of the wholy owned foreign operations to participate in a global or transnational strategy 8 -19

Complementarity of trade and FDI • Many exports would not occur if overseas investments did not exist – factor mobility via FDI often stimulates trade because of the need for: » components » complementary products » equipment for subsidiaries 8 -20

Meaning of Foreign Direct Investment (FDI) Concept of control • Control must accompany the investment • 100 percent share does not guarantee control – government intervenes in company operations • Direct investment usually implies an ownership share of 10 to 25 percent n Companies are reluctant to transfer vital resources to another organization without control • Capital • Patents • Trademarks • Management know-how 8 -21

Concern about control Government concern—when foreign investors control a company, decisions of national importance may be made abroad Investor concern—transfer of resources to acquiring company –appropriability theory—company receiving resources may undermine the competitive position of the company transferring them –Internalization—control by self-handling of operations 8 -22

Control and Costs Control inherent in FDI may: • Decrease operating costs • Increase rate of technology transfer, due to: • Parent and subsidiary share common corporate culture • Company can use its’ own managers • Company can avoid protracted negotiations with another company • Company can avoid problems of enforcing and agreement 8 -4

Methods for Making FDI • Assets employed: usually an international capital movement that crosses borders • Acquisition: purchase of existing company – Easy to execute – Useful if local requirements mandate localized adoption to operate – Foreign personal may be hard to hire – Best if international company is attempting to acquire knowledge – Gain goodwill and brand identification • Building: using local resources to start from construct facilities and build a labor pool 8 -11

Buy-versus-Build Decision Reasons for buying • Does not add further capacity to the market • Avoiding start-up problems • Easier financing Reasons for building • No desired company is available for acquisition • Acquisition will carry over problems • Acquisition is harder to finance 8 -25

Relationship Of FDI To Companies’ Objectives FDI may be more risky than some other forms of IB • Businesses and governments are motivated to engage in FDI in order to: – expand sales – acquire resources – minimize competitive risk • Governments may use FDI for political objectives 8 -26

Motivation for FDI as an Alternative or Supplement to Trade SALES EXPANSION OBJECTIVES • Overcome high transport costs RESOURCE ACQUISITION OBJECTIVES • Savings through vertical integration • Domestic capacity • Gains from scale economies • Trade restrictions • Savings through rationalized production • Gain access to cheaper or different resources and knowledge • Barriers because of country -of-origin effects • Need to lower costs as (nationalism, product matures image, delivery risk) • Gain governmental • Lower productions costs investment incentives abroad RISK MINIMIZATION OBJECTIVES • Diversification of customer base (same motivation as for sales expansion) POLITICAL OBJECTIVES Influence companies, usually through factors under resource acquisition objectives • Diversification of supplier base (same motivation as for resource acquistion objectives • Following customers • Preventing competitors’ advantage 8 -27

Why Host Intervenes in FDI Initial FDI boosts economy Balance of Payments + FDI may decrease import demand FDI may generate exports Access technology Obtain resources and benefits Access management skills + Create employment 8 -28

Why Home Intervenes in FDI – Removes resources from the nation – Can eliminate an export market – Might eliminate domestic jobs + May improve national competitiveness + Can offshore ‘sunset’ industries 8 -29

Host Promotion Methods Financial incentives Infrastructure improvements Low or waived taxes Low-interest loans Improved seaports, roads, telecommunications networks 8 -30

Host Restriction Methods Ownership restrictions Performance demands Prohibit investment in certain industries or businesses Local content reqts. Technology transfers Export targets 8 -31

Home Promotion Methods Insurance on assets abroad Loans and loan guarantees Tax breaks on profits earned abroad Special tax treaties Persuade other nations to accept FDI 8 -32

Home Restriction Methods Higher tax rates on foreign income Sanctions on specific nations 8 -33