Discussion

CH:8. Foreign Direct Investment

What Is FDI? Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country

o The firm becomes a multinational enterprise FDI can be in the form of

o Greenfield investments - the establishment of a wholly new operation in a foreign country o Acquisitions or mergers with existing firms in the foreign country

Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments

Why Do Firms Choose Acquisition Versus Greenfield Investments?

Firms prefer to acquire existing assets because :

o Mergers and acquisitions are quicker to execute than greenfield investments o It is easier and perhaps less risky for a firm to acquire desired assets than build them from the

ground up o Firms believe that they can increase the efficiency of an acquired unit by transferring capital,

technology, or management skills

What Are The Patterns Of FDI? The flow of FDI - the amount of FDI undertaken over a given time period

o Outflows of FDI are the flows of FDI out of a country o Inflows of FDI are the flows of FDI into a country

The stock of FDI - the total accumulated value of foreign-owned assets at a given time Both the flow and stock of FDI have increased over the last 30 years

FDI Outflows 1982-2010 ($ billions) FDI Inflows by Region 1995-2010 ($ billion)

The growth of FDI is a result of 1. A fear of protectionism

Want to circumvent trade barriers 2. Political and economic changes

Deregulation, privatization, fewer restrictions on FDI 3. New bilateral investment treaties

Designed to facilitate investment 4. The globalization of the world economy

Many companies now view the world as their market Need to be closer to their customers

What Is The Source Of FDI?

Cumulative FDI Outflows 1998-2010 ($ billions)

Why Choose FDI? Question: Why choose FDI not exporting or licensing?

1. Exporting - producing goods at home and then shipping them to the receiving country for sale 2. Licensing -

royalty fee on every unit that the foreign entity sells Internalization theory (aka market imperfections theory)

Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace Multipoint competition

Vernon - firms undertake FDI at particular stages in the life cycle of a product eclectic paradigm - it is important to consider

Location-specific advantages - that 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

What Are The Theoretical Approaches To FDI? The radical view - the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries The free market view - international production should be distributed among countries according to the theory of comparative advantage Pragmatic nationalism - FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect)

What Does FDI Mean For The Host Country? Benefits of inward FDI for a host country

Resource transfer effects Employment effects Balance of payments effects Effects on competition and economic growth

Costs of inward FDI for a host country Adverse effects on competition within the host nation Adverse effects on the balance of payments Perceived loss of national sovereignty and autonomy

What Does FDI Mean For The Home Country? Benefits of FDI for the home country include:

The positive effect on the capital account from the inward flow of foreign earnings The employment effects that arise from outward FDI The gains from learning valuable skills from foreign markets that can subsequently be transferred

back to the home country Costs of FDI for the home country include:

The negative effect on the balance of payments Employment may also be negatively affected if the FDI is a substitute for domestic production

How Does Government Influence FDI? Governments can encourage outward FDI

o Government-backed insurance programs to cover major types of foreign investment risk Governments can restrict outward FDI

o Limit capital outflows, manipulate tax rules, or outright prohibit FDI Governments can encourage inward FDI

o Offer incentives to foreign firms to invest in their countries Governments can restrict inward FDI

o Use ownership restraints and performance requirements

What Does FDI Mean For Managers?

Managers need to consider what trade theory implies about FDI, and the link between government policy and FDI

The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning

foreign production facilities and where to make a foreign direct investment

A Decision Framework