Chapter 8

Chapter 8: Foreign Direct Investment 

• Definition of FDI according to US Department of commerce: 

  • FDI occurs when businesses take a 10% interest taken in a foreign business entity

• Definitions such as stock, flow, direction, trends

  • Important terms:

    • Flow of FDI - FDI amount undertaken overtime

    • Stock of FDI - total accumulated value of foreign-owned assets 

    • Outflows of FDI: flows of FDI out of country 

    • Inflows of FDI: Flow of FDI into a country 

  • Direction of FDI:

    • Historically, most FDI has been directed at developed nations (US & EUR)

    • Today, developing nations receive more FDI

      • East Eur and SE Asian (China) have received the most inflows

      • Latin America is starting to get more

      • China is becoming a major investor in Africa (extraction industries)

  • Trends in FDI:

    • FDI flow has grown more rapidly than world trade and output

      • Firms still fear protectionist policies

      • Shift towards democratic political institutions and free market economies encourages FDI 

      • Globalization prompts firms to have large presence in many regions of the world

    • Both the Flow and Stock of FDI in world economy have increased over last 30 years

    • The Pattern of FDI

      • Strategic Behavior

        • Knickerbocker explored the relationship between FDI and rivalry in oligopolistic industries: industries composed of a limited number of large firms.

          • FDI flows reflect strategic rivalry between firms

      • This theory can be extended to multipoint competition: when two or more enterprises encounter each other in different regional markets, national markets, or industries.

        • Firms will try to match other’s moves in different markets to try to hold each other in check.

    • The Eclectic Paradigm

      • Dunning's eclectic paradigm: 2 additional factors must be considered when explaining the rationale and the direction of FDI

        • Location-specific advantages: 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.

        • Externalities: knowledge spillovers that occur when companies in the same industry locate in the same area.

  • Political Ideology and FDI

    • Political Ideology

      • Ideology toward FDI has ranged from a radical stance that is hostile to all FDI to the non interventionist principle of free market economies.

    • The Radical View

      • MNE is an instrument of imperialist domination and a tool for exploiting host countries to exclusive benefit of capitalist imperialist home countries

    • The Free Market View:

      • International production should be distributed among countries according to theory of comparative advantage

        • Countries according to theory of comparative advantage 

          • Countries should specialize in the production of goods and services they can produce most efficiently. 

          • FDI by the MNE increases the overall efficiency of the world economy.

    • Pragmatic Nationalism 

      • FDI has benefits and costs

        • Benefits: inflows of capital, tech, skills and jobs

        • Costs: repatriation of profits to home country, a negative balance of payments effect

      • FDI should be allowed only if benefits outweighs the cots

        • Tendency to aggressively court FDI believed to be in the national interest by offering subsides

          • Also seen in competition between individual states in US

• Acquisitions, mergers, greenfield

  • Acquisitions are attractive because:

    • Quicker to execute than greenfield

    • Easier & less risky to acquire than build from ground up

    • Believes efficiency can increase by transferring capital, tech, & management

  • Greenfield investments: establishing new operations in foreign country 

• FDI vs. other entry modes 

• Other entry modes:

  • 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 the foreign entity sells.

    • FDI may be both expensive and risky compared to exporting and licensing

  • Limitations of Exporting:

    • Exporting stat can be limited by transport costs and trade barriers

    • When transport costs are high, exporting can be unprofitable 

      • Low value-to-weight ratio

    • FDI may be a response to trade barriers (import tariffs or quotas)

  • Limitations of Licensing

    • Internalization theory (or market imperfections approach):

      • Could result in firm’s giving away valuable tech knowledge to potential foreign competitor

      • Doesn’t give firm control over manufacturing, marketing, and strategy in foreign country to maximize profitability 

• Advantages of FDI

  • FDI will be favored over exporting when:

    • Transport costs are high

    • Trade barriers are high

  • FDI will be favored over licensing when:

    • Firm wants control over tech knowledge

    • Firm wants control over operations & business strat

    • Firm’s capabilities are not amenable to licensing

  • Host country benefits from FDI:

    • Resource transfer Effects

      • FDI can bring capital, tech, and management resources 

    • Employment effects

      • FDI can bring jobs 

    • Balance of payment effects (BOP): 

      • Records a country’s payments to and receipts from other countries

        • Current Account and Capital Account 

          • Merchandize 

          • Services

          • Unilateral transfer

        • Reserve account

      • The current account records country’s export and import of goods and services

      • A surplus is usually favored over deficit

    • FDI can help achieve a current account surplus if:

      • Substitute for imports of G&S

      • MNE uses foreign subsidiary to export G&S to other countries

• Sample Question:

  • According to the U.S. Department of Commerce, what occurs whenever a U.S. citizen, organization, or affiliated group takes an interest of 10 percent or more in a foreign business entity 

    • Privatization  

    • An absolute advantage 

    • Foreign direct investment 

    • All of the above