Assignment 2.2 International Business

MGMK 4710

INTERNATIONAL BUSINESS

Chapter 15. FOREIGN DIRECT INVESTMENT AND COLLABORATION

https://www.selectusa.gov/FDI-in-the-US Foreign Direct Investment in the United States

https://www.theglobaleconomy.com/USA/fdi_dollars/

I. INTRODUCTION

International trade leads to global efficiency. That is why countries trade (export or import). However, under certain conditions, trade may not lead to global efficiency. In that case, MNEs may choose to either produce themselves or collaborate with other firms in foreign markets.

II. WHY EXPORTING MAY NOT BE FEASIBLE

There are several reasons why trading may not be the best option for MNEs.

A. It is cheaper to produce abroad: Producing in foreign countries may be cheaper that producing at home to export.

B. Transportation costs too much: Some products and services become impractical to export after transportation costs are added to production costs, especially if the target market is farther from the home market.

C. Domestic capacity is not enough: When demand exceeds production capacity at home, new facilities located in foreign countries may be needed.

D. Products and services need to be customized: When foreign markets have unique product requirements, MNEs may need to invest directly in in those locations.

E. Trade Restrictions Hinder Imports: In situations where significant tariffs exist, MNEs may choose to avoid barriers through production in the target country.

F. Country of origin effects: If consumers prefer goods produced in their own country over imports because of nationalistic feelings, MNEs should produce in those countries. Likewise, MNEs may want to change their location if consumers prefer imported goods from specific countries due to a perception that those products are superior.

III. FOREIGN DIRECT INVESTMENT

MNEs are trading, both within regions (e.g. European Union) and worldwide. Increasingly also, a growing number of MNEs are locating productive activities in foreign countries.

A. Understanding foreign direct investment (FDI):

Foreign direct investment (FDI) is performing, controlling and managing activities located in a foreign country. To qualify as a foreign direct investment, the investor must have some control of the operation (partial or total control). A total (100%) control of an FDI is known as a wholly owned subsidiary.

A home country is the country of origin of the MNE. A host country is the foreign country in which an MNE has operations. FDI inflow is FDI moving into a country in a year. FDI outflow is FDI moving out of a country in a year. Horizontal FDI is a type of FDI whereby the activities that an MNE performs in its home country are the same that it performs in a host country. Vertical FDI is a type of FDI whereby an MNE performs activities in different stages of the value chain in a host country.

B. Forms of (how to make) an FDI:

MNEs can either acquire an interest in an existing company or construct new facilities:

1. Acquisition. It is an FDI whereby an MNE buys an existing company in a host country. MNEs make acquisitions to avoid adding further capacity to the market, to avoid start-up problems, obtain easier financing, and get an immediate cash flow rather than tying up funds during construction. A company may also save time, reduce costs, and reduce risks by buying an existing company.

2. Greenfield investments. It is an FDI whereby an MNE establishes a wholly new activity in a host country. MNEs choose to build if no suitable company is available for acquisition, if the acquisition is likely to lead to carry-over problems, and if the acquisition is harder to finance. In addition, local governments may prevent acquisitions because they want more competitors in the market and fear foreign domination.

C. Reasons for choosing FDI (as opposed to trade):

1. Internalization: A strategy whereby an MNE performs activities itself (instead of buying them) because of the imperfect rules governing international market transactions (market imperfections).

2. Location-specific advantages: Resources (cheap labor, raw materials, skilled workers, large market) that can only be found in some countries/regions of the world.

3. Overcoming trade barriers (protectionism): Higher tariffs and other non-tariffs barriers have resulted in MNEs investing directly in a country

D. Political ideologies about FDI:

1. Free market view: A political ideology that suggests that MNEs should undertake FDI in any country they want, unrestricted by government intervention, to benefit from comparative advantage

2. Radical view: A political ideology that sees MNEs as a tool of domination (imperialism) of host countries through the exploitation of foreign economies’ resources to the exclusive benefit of MNEs’ capitalist-imperialist home countries

3. Pragmatic view: A political ideology that argues that as FDIs have both benefits and costs, host countries should approve FDI only when its benefits outweigh its costs.