MGT 321 - discussion

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Chapter 8 Foreign Direct Investment

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Learning Objectives LO 8-1 Recognize current trends regarding foreign direct

investment (FDI) in the world economy.

LO 8-2 Explain the different theories of FDI. LO 8-3 Understand how political ideology shapes a

government’s attitudes toward FDI.

LO 8-4 Describe the benefits and costs of FDI to home and host countries.

LO 8-5 Explain the range of policy instruments that governments use to influence FDI.

LO 8-6 Identify the implications for managers of the theory and government policies associated with FDI.

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Introduction Foreign direct investment (FDI)

• Occurs when a firm invests directly in new facilities to produce and/or market in a foreign country (10 percent or more)

• The firm becomes a multinational enterprise

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Foreign Direct Investment in the World Economy 1 of 5

Flow of FDI - the amount of FDI undertaken over a given time period

• Outflows―flows of FDI out of a country • Inflows―flows of FDI into a country

Stock of FDI - the total accumulated value of foreign-owned assets at a given time

Learning Objective 8-1 Recognize current trends regarding foreign direct investment (FDI) in the world economy.

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Foreign Direct Investment in the World Economy 2 of 5

Trends in FDI • Increase in both flow and stock of FDI over past 25

years

• Growing more rapidly than world trade and world output

• Way to circumvent trade barriers

• Political and economic changes

• Shift toward democratic political institutions and free market economies

• Globalization

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Figure 8.1 FDI outflows, 1990–2016 ($ billions)

Source: UNCTAD statistical data set, http://unctadstat.unctad.org

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Foreign Direct Investment in the World Economy 3 of 5

The Direction of FDI • Historically, mostly directed at developed nations

• U.S. is a target for FDI inflows • Large and wealthy domestic market

• Dynamic and stable economy

• Favorable political environment and openness to FDI

• European inflows mainly from the U.S. and other European nations

• China has also been a recipient of FDI recently

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Figure 8.2 FDI inflows by region, 1995–2016 ($ billions)

Source: UNCTAD statistical data set, http://unctadstat.unctad.org

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Foreign Direct Investment in the World Economy 4 of 5

The Source of FDI • U.S. is the largest source since WWII

• Six countries (U.S., UK, France, Germany, Japan, and the Netherlands) account for 60 percent of all FDI outflows

• China became a major foreign investor around 2005, especially in less developed nations

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Figure 8.3 Cumulative FDI outflows, 1998–2016 ($ billions)

Jump to long description in appendix

Source: UNCTAD statistical data set, http://unctadstat.unctad.org

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Foreign Direct Investment in the World Economy 5 of 5

The Form of FDI: Acquisitions versus Greenfield Investments

• Greenfield investment • Acquisitions and mergers

• Quicker to execute

• Can acquire valuable strategic assets

• Can increase the efficiency of the acquired unit by transferring capital, technology, or management skills

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Theories of Foreign Direct Investment 1 of 7 Learning Objective 8-2 Explain the different theories of FDI.

Three complementary perspectives 1. Seeks to explain why a firm will favor direct

investment as a means of entering a foreign market when two other alternatives, exporting and licensing, are open to it

2. Attempts to explain the observed pattern of foreign direct investment flows

3. The eclectic paradigm, attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment

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Theories of Foreign Direct Investment 2 of 7

Why Foreign Direct Investment? • Exporting • Licensing

FDI is expensive and risky compared with exporting and licensing

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Theories of Foreign Direct Investment 3 of 7 Why Foreign Direct Investment? continued

• Limitations of exporting • Transportation costs and trade barriers

• By limiting imports through quotas and tariffs, governments increase the attractiveness of FDI and licensing

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Theories of Foreign Direct Investment 4 of 7 Why Foreign Direct Investment? continued

• Limitations of licensing • Internalization theory

• Market imperfections

• Licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitor.

• Licensing does not give a firm the tight control over production, marketing, and strategy in a foreign country that may be required to maximize its profitability.

• The firm’s competitive advantage is based on the management, marketing, and manufacturing capabilities, which is not amenable to licensing.

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Theories of Foreign Direct Investment 5 of 7 Why Foreign Direct Investment? continued

• Advantages of Foreign Direct Investment • When transportation costs or trade barriers make exporting

unattractive.

• When a firm wishes to maintain control over its technological know-how, or over its operations and business strategy, or when the firm’s capabilities are simply not amenable to licensing.

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Theories of Foreign Direct Investment 6 of 7 The Pattern of Foreign Direct Investment

• Strategic Behavior

• Knickerbocker - relationship between FDI and rivalry in oligopolistic industries

• Oligopoly

• Interdependence between firms in an oligopoly leads to imitative behavior

• Imitative behavior also occurs in FDI

• Multipoint competition

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Theories of Foreign Direct Investment 7 of 7

The Eclectic Paradigm - John Dunning • Location-specific advantages • Difficult for a firm to license its own unique

capabilities and know-how.

• Combining location-specific assets or resource endowments with the firm’s own unique capabilities often requires foreign direct investment.

• Externalities

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Political Ideology and Foreign Direct Investment 1 of 4

Learning Objective 8-3 Understand how political ideology shapes a government’s attitudes toward FDI.

The Radical View • Roots in Marxist political and economic theory

• The multinational enterprise (MNE) is an instrument of imperialist domination

• Influential view from 1945-1980s

• No longer widely accepted

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Political Ideology and Foreign Direct Investment 2 of 4

The Free Market View • Roots in classical economic theory and trade theories

of Adam Smith and David Ricardo

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

• FDI is a benefit to both the source country and the host country.

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Political Ideology and Foreign Direct Investment 3 of 4

Pragmatic Nationalism • FDI has both benefits and costs

• Pursue policies designed to maximize the national benefits and minimize the national costs

• Aggressively court FDI believed to be in the national interest

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Political Ideology and Foreign Direct Investment 4 of 4

Shifting Ideology • Decline in radical ideology

• Increase in free market ideology, more liberal foreign investment regime

• Surge in FDI worldwide • China, Vietnam, India

• Some nations more hostile to FDI • Venezuela and Bolivia

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Benefits and Costs of FDI 1 of 8 Learning Objective 8-4 Describe the benefits and costs of FDI to home and host countries.

Host-Country Benefits • Resource-transfer effects

• Capital, technology, management resources

• Employment effects • Brings jobs to a host country that would otherwise not be

created there

• May be offset by loss of jobs in home country

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Benefits and Costs of FDI 2 of 8 Host-Country Benefits continued

• Balance-of-Payments Effects • Balance of payments accounts track payments and

receipts

• Current account tracks exports and imports • A current account deficit, or trade deficit, arises when a

country is importing more goods and services than it is exporting.

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Benefits and Costs of FDI 3 of 8 Host-Country Benefits continued

• Balance-of-Payments Effects continued • FDI helps with a current account surplus

• By substituting for imports

• When the MNE uses a foreign subsidiary to export goods and services to other countries

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Benefits and Costs of FDI 4 of 8 Host-Country Benefits continued

• Effect on competition and economic growth • Greenfield investment creates new enterprise

• Services where exporting is not an option

• Increases competition, stimulates investment, lower prices

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Benefits and Costs of FDI 5 of 8 Host-Country Costs

• Adverse effects on competition • Subsidiaries of foreign MNEs may have greater economic

power than indigenous competitors

• Adverse effects on the balance of payments • Subsequent capital outflow

• Imports of inputs from abroad

• Possible effects on national sovereignty and autonomy • A loss of economic independence

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Benefits and Costs of FDI 6 of 8 Home-Country Benefits

• The home country’s balance of payments benefits from the inward flow of foreign earnings

• Employment effects

• Reverse resource-transfer effect • MNE learns valuable skills from its exposure to foreign

markets that can subsequently be transferred back to the home country.

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Benefits and Costs of FDI 7 of 8 Home-Country Costs

• Balance-of-payments effects of outward FDI • Initial capital outflow

• The current account of the balance of payments 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 balance of payments suffers if the FDI is a substitute for direct exports.

• Employment effects • When FDI is a substitute for domestic production

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Benefits and Costs of FDI 8 of 8 International Trade Theory and FDI

• Offshore production • May stimulate economic growth in home country

• May result in lower prices

• Makes a company more competitive

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Government Policy Instruments and FDI 1 of 4 Learning Objective 8-5 Explain the range of policy instruments that governments use to influence FDI.

Home-Country Policies • Encouraging outward FDI

• Government-backed insurance programs

• Government loans

• Elimination of double taxation of foreign income

• Relaxation of restrictions on FDI by host countries

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Government Policy Instruments and FDI 2 of 4

Home-Country Policies continued • Restricting outward FDI

• Limit capital outflows

• Manipulate tax rules

• Prohibit investment for political reasons

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Government Policy Instruments and FDI 3 of 4

Host-Country Policies • Encouraging inward FDI

• Incentives such as tax concessions, low-interest loans, grants or subsidies

• Restricting inward FDI • Ownership restraints

• Performance requirements

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Government Policy Instruments and FDI 4 of 4

International Institutions and the Liberalization of FDI • World Trade Organization

• Push for liberalization of regulations governing FDI • Two extensive multinational agreements were reached in

1997 to liberalize trade in telecommunications and financial services

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Managerial Implications

FDI and Government Policy • The Theory of FDI

• Dunning’s locations specific advantages argument explains the direction of FDI, but not why firms prefer FDI to exporting or licensing

• Internalization theories identify the relative profitability of FDI, exporting, and licensing

• Government policy • Attitude toward FDI

Learning Objective 8-6 Identify the implications for managers of the theory and government policies associated with FDI.

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Figure 8.4 A decision framework

Jump to long description in appendix

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Appendix of Image Long Descriptions

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Appendix 1 Figure 8.3 Cumulative FDI outflows, 1998–2016 ($ billions).

United States $4500 billion

United Kingdom $1500 billion

Netherlands $1300 billion

Germany $1400 billion

Japan $1450 billion

France $1500 billion

Return to original slide

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Appendix 2 Figure 8.4 A decision framework

The diagram reads as follows:

How high are transportation costs and tariffs?

If low, then export.

If high, then ask Is know-how amenable to licensing?

If no, then FDI.

If yes, then ask Is tight control over foreign operation required?

If yes, then FDI.

If no, then ask Can know-how be protected by licensing contract?

If no, then FDI.

If yes, then license.

Return to original slide