THE EXPANDING ROLE OF FOREIGN DIRECT INVESTMENT
What is FDI?
Foreign direct investment (FDI) occurs when a company invests directly in
business operations in another country. There are two main forms of FDI:
Greenfield investment involves purchasing land and constructing
entirely new facilities and operations abroad from the ground up.
This allows a customized subsidiary or operations base to suit the
investing company's needs in that country.
Mergers and acquisitions (M&As) mean buying part or all of an
existing company located in another country. This allows faster
establishment in the market by acquiring existing resources like
brand recognition, distribution channels, and local relationships.
Companies pursue FDI for several key strategic reasons:
To establish operations in a promising new geographic market and
gain foothold for future growth there.
To increase the global competitiveness of the company by accessing
resources or capabilities available abroad.
To fill gaps in the company's product line by acquiring technologies
or intellectual property rights that complement their own.
To reduce costs in areas like research and development, production,
distribution through utilization of foreign resources and capabilities.
Trends in FDI
Foreign direct investment expanded rapidly starting in the 1990s,
exceeding $1.9 trillion globally in 2007 before the global financial crisis
struck. FDI then fell 33% during the crisis period of 2008-2009 as
economic uncertainty led companies to pull back on investments. It took
over 2 years for FDI to recover back to the pre-crisis level.
FDI declined again in 2019-2020 due to increased international trade
tensions and policy uncertainty in some nations. The COVID-19 pandemic
in 2020 caused another steep one-third drop in global FDI flows to under
$1 trillion that year as travel restrictions and economic uncertainty
prevailed.
FDI Recipients
Historically the developed nations have been the largest recipients of
incoming FDI, holding the biggest stock accumulated over time. But in
2014, developing countries attracted more total FDI for the first time,
accounting for 55% of global inflows. This reverted back briefly before
developing countries again attracted nearly equal FDI in 2018-2019. In the
pandemic year 2020, developing countries received almost twice as much
FDI as developed nations. China was the top developing country recipient,
being one of the only major economies to grow that year.
FDI Sources
The developed countries have also traditionally been the largest sources
of outward FDI. FDI outflows from developed nations tend to go to other
developed nations, for example European companies acquiring Canadian
or US firms.
Developing countries are steadily increasing as sources of FDI outflows as
their companies expand globally. China is now a top FDI source as its firms
internationalize. FDI outflows from developing countries will likely continue
to grow as their economies develop further.
The pandemic could affect global FDI flows for years. A full recovery to
pre-pandemic levels may not occur until 2028 due to factors like travel
restrictions lingering and uncertainty caused by COVID-19's impacts.
THEORIES EXPLAINING FOREIGN DIRECT INVESTMENT
The Motivations Behind Foreign Direct Investment
International Product Life Cycle
States companies first export, then undertake FDI as product
matures and becomes standardized.
FDI allows local production to supply foreign demand and eventually
shifts to low-cost locations.
Limitations: Doesn't explain why FDI chosen over other modes like
licensing production. Or exporting from home country versus local
production.
Market Imperfections
FDI undertaken to get around inefficient markets and reduce
transaction costs.
Trade barriers like tariffs encourage investment in country to avoid
them.
Specialized knowledge of workers hard to transfer other than
through FDI. Fear of creating competitor by licensing knowledge also
encourages FDI.
Eclectic Theory
FDI occurs when location, ownership, and internalization advantages
make investment appealing.
Location advantages like low-cost labor or resources. Ownership of
special assets like brands or tech. Internalization of activities versus
using market transactions.
Market Power
FDI to gain dominant industry position and increase profit potential.
Vertical integration into supplying inputs or distributing outputs to
control value chain.
Overall, FDI driven by combination of strategic factors - markets,
resources, capabilities, industry control.
CRITICAL CONSIDERATIONS IN FOREIGN DIRECT INVESTMENT
Control Over Operations
High ownership can allow control, but governments may require
shared ownership.
IBM once insisted on 100% ownership but made concessions like
training local managers.
Most countries now welcome FDI. Cooperation critical as controls
can backfire.
Purchase Existing Business or Build New
Buying can provide facilities, equipment, staff, brand awareness if
suitable target exists.
Building from scratch (greenfield) allows custom design but permits
can be challenging.
Cemex succeeds by acquiring inefficient cement plants worldwide
and improving them.
Greenfield common in developing countries with lack of adequate
existing operations.
Managing Production Costs
Wages, benefits, regulations all impact costs and need to be
thoroughly analyzed.
Rationalized production spreads component production globally,
final assembly in one place.
But work stoppages in one country can disrupt entire process.
Research and Development
Alliances and acquisitions gain access to expensive R&D like biotech
and pharma deals.
India a key destination for R&D investment due to skilled talent.
Market and Industry Factors
FDI to understand customer preferences, follow clients, cluster near
partners.
Produce in country with quality associations.
Follow rivals to match strategic moves and avoid missing
opportunities.
