Chapter 7

Chapter 7: Foreign Direct Investment

Learning Objectives

• Current Trends in FDI: Understand the trends regarding foreign direct investment (FDI) in the world economy, focusing on geographical shifts, industry influences, and evolving regulatory environments.

• Theories of FDI: Be able to explain the different theories that describe FDI, including the Eclectic Paradigm, Internalization Theory, and the Uppsala Model, to provide a holistic view of why firms engage in FDI.

• Political Ideology: Recognize how political ideology influences government attitudes toward FDI and how these attitudes can change over time, impacting investment flows and economic policies.

• Benefits and Costs of FDI: Understand the advantages and disadvantages of FDI for both home and host countries, including potential economic growth and local employment versus concerns regarding sovereignty and environmental impact.

• Policy Instruments: Identify the range of policy instruments that governments utilize to influence FDI, including tariffs, subsidies, and foreign investment regulations.

• Managerial Implications: Recognize the implications for managers derived from theories and government policies related to FDI, such as strategic decision-making based on market entry modes and risk assessment.

FDI in the World Economy

Definition of FDI

• Foreign Direct Investment (FDI): Direct investment by a multinational enterprise (MNE) in facilities to produce or market a good or service in a foreign country, involving significant managerial control and long-term interest.

FDI Metrics

• Flow of FDI: The amount of FDI undertaken in a specified time frame (e.g., annually), providing insights into current investment trends.

• Stock of FDI: The total accumulated value of foreign-owned assets in a country, reflecting the level of foreign investment over time.

• Outflows of FDI: FDI moving out of a country, often driven by factors such as favorable foreign market conditions or investment opportunities.

• Inflows of FDI: FDI entering into a country, which can be influenced by economic policies, stability, and investment incentives.

Trends in FDI

• Global Trends: An analysis of FDI outflows from 1990 to 2022, illustrating significant increases in investment activity, varied by region and industry, and the impact of technological advancements.

Types of FDI

• Greenfield Investment: Establishing new operations in a foreign country from the ground up, which can involve significant capital investment but also allows for complete control over the operation.

• Acquisitions: Merging with or acquiring existing firms in a foreign country, which can provide immediate access to market share but may come with integration challenges.

• Debate: The pros and cons of acquisitions versus greenfield investments, including speed of entry, investment risk, and cultural integration.

FDI Contexts: Canada's Case

• Inflows vs. Outflows: Historically, Canada has seen lower FDI inflows compared to outflows, exemplified by 2022 figures showing $53 billion inflow against $79.2 billion outflow, reflecting the competitive international landscape for investments.

• Factors Influencing FDI Flows: Influences include geopolitical issues (e.g., Ukraine conflict posing risks to investment), post-pandemic economic recovery, tax policies, and trade agreements.

Theories of FDI

Theory Overview

• Explanation of FDI Choices: Theories explain reasons why firms prefer direct investment over alternative economic engagements like licensing or exporting, focusing on market access, resource acquisition, and competitive advantage.

• Simultaneous FDI: Discusses why firms often choose to invest simultaneously in multiple locations within the same industry, often driven by market demand or strategic alliances.

• Eclectic Paradigm: Combines ownership, location, and internalization advantages into one framework to explain FDI decisions effectively.

Comparison of FDI Strategies

• Exporting: Selling products made in one country to another; it often involves lower risk but may be limited by transportation costs.

• Limitations of Exporting: High transportation costs can negate profits, especially for products with low value-to-weight ratios, making local production a better option.

• Licensing: Permitting a foreign company to produce and sell a product, which can provide quick access to foreign markets but may risk losing technological know-how and diminished control over production.

Strategic Behavior in FDI

• Oligopoly: An industry structure dominated by a few large firms, where strategic decisions by one player often influence others in the market.

• Multipoint Competition: Competitors engaging in various regional markets and across different industries, leading to complex inter-firm dependencies.

The Eclectic Paradigm by Dunning

• Location-Specific Advantages: Emphasizes the significance of combining unique resources tied to specific geographic locations with a firm’s existing assets to maximize FDI effectiveness.

Views on FDI

• Radical View: Argues that MNEs often exploit host countries for the exclusive benefit of home countries, leading to adverse effects on local economies.

• Free Market View: Advocates that countries should specialize based on comparative advantage, positioning FDI as beneficial for global trade.

• Pragmatic Nationalism: Recognizes both the benefits and costs of FDI in a balanced manner, acknowledging local opportunities as well as challenges.

Current Shifts in FDI Ideology

• Liberalization Trends: Observes a decline in radical ideologies, with many governments moving towards liberalization of FDI, despite some resistance (e.g., Venezuela), indicative of changing thought in global investment governance.

Benefits and Costs of FDI

Host Country Benefits:

• Resource-Transfer Effects: Availability of foreign capital and skills resulting in improved local resource utilization.

• Employment Effects: Job creation through new business operations, fostering local economic development.

• Balance-of-Payments Effects: Positive impacts on national finances through increased tax revenues and foreign exchange inflows.

Host Country Costs:

• Competition Concerns: May harm local competitors and influence national sovereignty, raising questions about market dominance and control.

Home Country Benefits:

• Skill Enhancement: MNEs gain skills and insights from foreign subsidiaries, leading to enhanced innovation and competitiveness.

• Employment Effects: Potential job creation within headquarters as a result of increased foreign earnings.

• Reverse Knowledge Transfer: Insights and knowledge gained from foreign operations that can be reintegrated back into the home country business.

Home Country Costs:

• Balance of Payments Concerns: Potential outflows of capital that may negatively affect the home country’s economy.

• Job Loss Risks: Potential job losses in the home country due to offshoring and relocation of production facilities.

Government Policy Instruments and FDI

• Home Country Policies: Can either encourage or restrict outward FDI through tax incentives, grants, and investment promotion agencies.

• Host Country Policies: May promote or limit inward FDI through regulations, local content requirements, and industry restrictions.

International Institutions and Liberalization of FDI

• Multinational Institutions' Role: The involvement of multinational institutions in governing FDI increased significantly post-1995 following the establishment of the World Trade Organization, leading to more structured investment agreements and regulations.

Important Considerations for Business

• Transportation Costs and Tariffs: Assessing export strategies based on cost implications, particularly for industries with high transportation expenses.

• Decision Framework: Evaluating whether to opt for horizontal FDI, balancing control over operations and the protection of proprietary technology and processes.

Closing Case: Starbucks’ FDI Direction

• Starbucks' Expansion: A detailed examination of its historical investment strategies and the reasons behind its success in China, taking into account the local political, economic, and cultural contexts that influenced its market entry and operation strategies.