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39 Cards in this Set
- Front
- Back
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Foreign Direct Investment (FDI)
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Occurs when a firm invests directly in facilities to provide or market a product in a foreign country.
• Occurs whenever a U.S., citizen, organization, or affiliate group takes an interest of 10% of more in a foreign business entity. Once a firm undertakes FDI it becomes a multinational enterprise. |
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Two main forms of FDI:
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1.Greenfield Investment – Establishing a new operation in a foreign country.
2.Acquiring of merging with an existing firm in the foreign country. |
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The Flow of FDI
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The amount of FDI undertaken over a given time (normally a year).
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Stock of FDI
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The total accumulated value of foreign owned assets at a given time
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Outflows of FDI
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The flow of FDI out of a country.
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Inflows of FDI
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Flow of FDI out of the country.
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Reasons FDI has grown more rapidly than world trade
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• Despite the general decline in trade barriers over the past 30 years, business firms still fear protectionist pressures.
• Most of the recent increase in FDI is driven by political and economic changes hat have been occurring in many of the world’s developing nations. The shift toward democratic political institutions and free market economies has encouraged FDI. |
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In history, where has most FDI has been aimed at ?
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In history, most FDI has been aimed at the developed nations of the world. 1980’s and 90’s the US was the favorite target of FDI inflows. Due to its large and wealthy domestic markets, its dynamic and stable economy, favorable political environment, and the openness of the country to FDI.
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WHat happened tp the annual inflow of FDI Between 1985 to 1990 ?
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Between 1985 to 1990, the annual inflow of FDI into developing nations increased up to 17.4 percent of the total global flow.
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Grossed Fixed Capital formation
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Summarizes the total amount of capital invested in factories, stores, office buildings, and the like.
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How are capital investments and future growth prospects connected ?
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The more favorable the capital investments in an economy the more favorable its future growth prospects are likely to be. Viewed in this manner, the FDI could be seen as a important source of capital investment and a determinant of the future growth rate of an economy.
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Who has been the largest source of FDI since WWII? WHo are other important sources of FDI ?
What percentage of FDI did these countries count for from 98-2006? 3 Reasons these countries are the key sources of FDI? |
United States has been the largest source country of the FDI since WWII. UK, France, Germany, Netherlands, and Japan are also important source countries. Collectively all 6 counted for 56% of all FDI outflows from 98-2006.
Reasons these countries are the key sources of FDI: •They’re predominate in the rankings of the world’s multinationals. •Were the most developed nations with the largest economies during much of the postwar period and home to many of the largest and best capitalized industries. •Many had long history as trading nations and naturally looked to foreign markets to fuel their economic expansion. |
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What does Data suggests that the majority of cross border investments are in the form of ?
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mergers and acquisitions
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3 Reasons firms would prefer to acquire existing assets rather than undertake Greenfield investments
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•Mergers and acquisitions are quicker to execute than Greenfield investments.
•Foreign firms are acquired because those firms have valuable strategic assets. Such as brand loyalty, customer relationships, trademarks or patents, distribution systems, production systems, and the like. •Firms make acquisitions because they believe they can increase the efficiency of the acquired unit by transferring capital, technology, or management skills. |
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4 factors that has led to the shift of FDI away from extractive industries and manufacturing toward services.
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1.The shift reflects the general move in many developed economies away from manufacturing and toward service industries. BY 2000 service industries counted for 72% of the GDP in developed countries and 52% in developing countries.
2.Many services cannot trade internationally. They need to be produced where they are consumed. 3.Many countries have liberalized their regimes governing FDI in services. This has made large inflows possible. 4.The rise of the 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. |
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What theory of FDI attempts to explain the observed pattern of foreign direct investment flows:
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Eclectic Paradigm - The theory that combining location specific assets of resource endowments and the firms own unique assets often requires FDI; it requires the firm to establish production facilities where those foreign assets or resource endowments are located.
- Attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment. Its “eclectic” because the best aspects of the others theories are taken and combined into a single explanation. |
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Why is FDI expensive and Risky ?
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expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise.
is risky because of the problems associated with doing business in a different culture where the rules of the game may be very different. And its likely to make costly mistakes due to its ignorance |
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Exporting
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Producing goods at home and then shipping them to the receiving country for sale.
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Licensing
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Involves granting a foreign entity (the licensee) the right to produce and sell the firm’s product in return for a royalty fee on every unit sold.
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Limitations of Exporting
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-Exporting strategies are often constrained by transportation costs and trade barriers. When added to production cost it can become unprofitable to ship products over a long distance.
oEspecially true for products with a low value to weight ratio and can be produced in any location, this makes FDI more attractive. -Some firms undertake FDI as a response to import tariffs or quotas. Likewise governments can increase the attractiveness of FDI and licensing by limiting imports though quotas. |
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Internalization Theory (Market Imperfections Approach)
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The argument that firms prefer FDI over licensing in order to retain control over the know-how manufacturing, marketing, and strategy or because some firm capabilities are not amenable to licensing.
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3 major drawbacks of licensing as a strategy for exploiting foreign market opportunities, according to Internalization theory
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1. Licensing may result in a firm’s giving away valuable technological know how to a potential foreign competitor.
2. Licensing doesn’t give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. 3. The firm’s CA is based not as much on its products as on the management, marketing, and manufacturing capabilities that produces those products. Such capabilities are not amenable to licensing. a. Meaning a foreign licensee may not be able to produce the product as efficiently as the original firm. Meaning they are able to fully exploit the profit potential. |
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When one or more of these conditions hold, markets fail as a mechanism for selling know-how and FDI is more profitable than licensing
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When the firm…
1.… Has valuable know how that cannot be adequately protected by a licensing contract. 2.… Needs tight control over a foreign entity to maximize its market share and earnings in that country. 3.…skills and know how are not amenable to licensing. |
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2 Advantages of Foreign Direct Investment
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Firms favor FDI over exporting as a entry strategy when transportation costs or trade barriers make exporting unattractive.
Firms will favor FDI over licensing (or franchising) when it -wishes to maintain control over its technological know-how, or operations and business strategy. -When the firm’s capabilities are simply not amenable to licensing. |
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Two theories to observe in FDI flows:
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1. Strategic Behavior –F.T. Knickerbocker. Based on the ideas that FDI inflows are a reflection of strategic rivalry between firms in the global marketplace.
Oligopoly – Industry composed of a limited number of large firms. An industry where four firms control the domestic market. Critical interdependence among the firms. The critical interdependence anuses imitative behavior among the firms. If one cuts prices the others follow suit. 2. Multipoint Competition – When two or more enterprises encounter each other in different regional markets, national markets, or industries. Economic theory suggests that firms will try to match each other’s moves in different markets to try to hold each other in check. To ensure a rival doesn’t gain a commanding position in one market and the use profits generated there to subsidize competitive attacks in other markets. |
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- Location Specific Advantages
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Advantages that arise from utilizing resource endowments or assets that are tied to particular foreign location and that a firm finds valuable to combine with its own unique assets, such as technological, marketing, or management capabilities.
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- Externalities – Knowledge spillovers
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. When there is a high concentration of intellectual knowledge in the area, having a network of informal contacts allows firms to benefit for each other’s knowledge generation.
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The Radical View
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Derives from Marxist political and economic theory.
Radical writers argue that: - MNE is an instrument of imperialist domination - MNE extracts profits from host country and takes them home, meanwhile giving nothing of value to host country. - MNE exploits host country to the benefit of their capitalist-imperialist home countries. Very popular from 1945 – 1980 until the collapse of communism between 1989 and 1991. |
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3 reasons the radical view was in decline by the end of 1989
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1. The collapse of communism in Eastern Europe.
2. Generally abysmal economic performance of those countries that embraced the radical positions, and a growing belief by many of these countries that FDI can be an important source of technology and jobs and can stimulate economic growth. 3. The strong economic performance of those developing countries that embraced capitalism rather than radical theology. |
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The Free Market View
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Connected to the international trade theories of Adam Smith and D Ricardo.
- Argues that international production should be distributed among countries according to the theory of CA. - Countries should specialize in production of goods they produce most efficiently. - In this context, MNE is instrument for dispersing the production of goods and services to most efficient locations around globe. That way MNE increases the overall efficiency of the world economy. |
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Pragmatic Nationalism
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o FDI should be allowed as long as the benefits outweigh the costs.
- Another aspect is the tendency to aggressively court FDI believed to be in national interest. o By offering subsidies to foreign MNE’s in the form of tax breaks and subsidies View that FDI has both benefits and costs. - FDI benefits host country by bringing in capital, skills, technology, and jobs, but the benefits come at a cost. o The profits go abroad rather. - Foreign owned plants could also import parts from its home country which has negative complications for the host country’s balance of payments position. - Most countries has adopting a pragmatic stance pursue policies designed to maximize national benefits and minimize the national costs |
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Host Country Benefits of FDI
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o Resource Transfer Effects – Supplies capital, technology, and managements resources that otherwise would not be available and thus boost that country’s economic growth rate.
o Employments Effects – Brings jobs to a host country that would otherwise not be created there. The effects of FDI on employment are both direct and indirect Direct effect arises when a foreign MNE employs a number of host country citizens. Indirect effect arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE. o Balance of Payment Effects – FDI’s effect of a country’s balance of payments accounts is an important issue for most host countries. Balance of Payments Accounts – national accounts that track both payments to and receipts from foreigners. Governments become concerned when their country is running a deficit on the current account of their balance of payments. Current Account – Tracks the exports and import of goods and services. Deficit is when a country is importing more than its exporting. The only way to support a current account deficit in the long run is to sell assets to foreigners. |
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•2 ways FDI can help economy achieve a surplus
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• If FDI is a sub for imports of goods or services, the effect can improve the current account of balance of payments.
• When the NE uses a foreign subsidiary to export goods and services to other countries. |
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-Host Country Costs
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When a foreign subsidiary imports a substantial number of its inputs from abroad, this results in a debit on the current account of the hoist country’s balance of payments
o Adverse Effects on Competition – Host governments often worry about MNE’s having too much economic power. If it draws on funds generated elsewhere to subsidize its costs in the host market, it could drive domestic companies out of business and monopolize the market. But it’s a minor concern o Adverse Effects on the Balance of payments • Set against the initial capital inflow that comes with FDI must be subsequent outflow of earnings from the foreign subsidiary to its parent company. • These outflows show up as capital outflows on the balance of payments account. • Some governments respond to such outflows by restricting the amount of earnings that can be sent to a company’s home country. o National Sovereignty and Autonomy – Some host governments worry that FDI is accompanied by some loss of economic independence. Concern is that key decisions that can affect the country’s economy will be made by a foreign parent company that has no real commitment to the host country, over which the host country has no real control. |
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-Home Country Benefits
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o The home country’s balance of payments benefits from the inflow of foreign earnings.
o Benefits to the home country from outward arise from employment effects. Positive employment effects arise when the foreign subsidiary creates demand for home country exports. o When the home country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country. A reverse transfer resource effect |
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-Home Country Costs
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o Most important concerns center on the BOP and employment effects of outward FDI.
o Home country BOP may suffer in 3 ways: • BOP suffers from the initial capital outflow required to finance the AFDI. • The Current Account of the BOP suffers if the purpose of the foreign investment is to serve the home market from a low cost production location. • The Current account of the BIP suffers if the FDI is a sub for direct exports. |
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Offshore Production
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FDI undertaken to serve the home market. FDI. It may reduce home country employment but it may stimulate home country economic growth. Prices at home also fall as a result of FDI.
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•Home Country Policies used to regulate FDI
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o Encouraging Outward FDI:
Foreign Risk insurance - Insurance programs to cover major types of foreign investment risk. Risks also include war losses, nationalization, and the inability to transfer profits back home Capital Assistance – Special funds or bans that make government loans to firms wishing to invest in developing countries. Tax Incentives – the elimination of double taxation of foreign income Political Pressure – Using political influence to persuade host countries to relax their restriction on inbound FDI. o Restricting Outward FDI Limit capital inflows out of concern for the country’s BOP. Manipulate tax rules to encourage firms to invest at home Prohibit national firms from investing in certain countries for political reasons |
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•Host Country Policies used to regulate FDI
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o Encourage inward FDI
Offer incentives for countries to invest in their countries. Incentives are motivated by a desire to gain from the resource transfer and employment effects of FDI. Also motivated by a desire to capture potential FDI away from other potential host countries. o Restricting inward FDI Ownership restraints and performance requirements |
