Slide global business today chap006 foreign direct investment

• Why do firms choose FDI over exporting or licensing to enter a foreign market?. Foreign Direct Investment• Foreign direct investment FDI happens when a firm invests directly in facil

Foreign Direct Investment

6

Key Issues

• Why is FDI increasing?

• Why do firms choose FDI over exporting or

licensing to enter a foreign market?

• Why are certain locations attractive for FDI?

• How does political ideology influence government policy over FDI?

• From a host or source country perspective, what

are FDI’s costs and benefits?

Foreign Direct Investment

• Foreign direct investment (FDI) happens when

a firm invests directly in facilities in a foreign country

• A firm that engages in FDI becomes a multinational enterprise (MNE)

– Multinational = “more than one country”

• Factors which influence FDI are related to factors that stimulate trade across national borders

Foreign Direct Investment

• Involves ownership of entity abroad for

– production – Marketing/service – R&D

– Raw materials or other resource access

• Parent has direct managerial control

– The degree of direct managerial control depends

on the extent of ownership of the foreign entity and on other contractual terms of the FDI

– No managerial involvement = portfolio investment

FDI Growth in the World Economy

• FDI Outflow of $25 billion in 1975 increased to $1.3

trillion in 2000

• FDI flow accelerated more than world trade (x 5 and x 1.8 respectively)

• FDI Flow from all countries increased 1000%, trade

91%, world output 27% from 1984 to 1998

• FDI Stock increased to $3.5 trillion by 1997

• 63,000 parent firms with 690,000 foreign affiliates produced $14 trillion sales, almost twice global exports

• FDI growing faster than world trade

– Political risk issues – Economic reason issues – Globalization

Direction and Source of FDI

• Historically, FDI flow was to developed countries from other developed countries

– Much of this to the US

• Since 1985 there has been an increase of FDI towards developing countries

– Much to the emerging Asian and Latin America economies – Africa lagging

• Through 1970s US led in FDI outflows

– 1985-1990 Japan 1st, UK 2nd, US 3rd – Effect of ¥ increase in value

• In 2000 the USA received 21.6% of world FDI; the EU received 48.7%

Forms of FDI

• FDI forms

– Purchase of existing assets

• Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems

– New investment

• No local entity exists or is available for sale, local financial incentives may encourage, no inherited problems, long lead time to generation of sales or other desired outcome

– Participation in an international joint-venture

• Shared ownership with local and/or other non-local partner

Alternative Modes of Market Entry

• FDI

– FDI - 100% ownership – FDI < 100% ownership, International Joint Venture

• Majority, Equal Share, Minority Participation

• Strategic Alliances (non-equity)

• Franchising

• Licensing

• Exports

– Direct vs Indirect

Why FDI?

• FDI over exporting

– High transportation costs, trade barriers

• FDI over licensing or franchising

– Need to retain strategic control – Need to protect technological know-how – Capabilities not suitable for

licensing/franchising

Pattern of FDI

• Follow main competitors

– Oligopolistic industries – Interdependence of the few major competitors forces immediate strategic responses

• International product life-cycle (Vernon, see Ch 4)

• Eclectic paradigm of FDI (John Dunning)

– Combines ownership specific, location specific, and internalization specific advantages that drive FDI choice over a decision to enter through licensing or exports

Eclectic Paradigm of FDI (Dunning)

• Ownership advantage: creates a monopolistic advantage

which can be used to prevail in markets abroad

– Unique ownership advantage protected through ownership – e.g., Brand, technology, economies of scale, management know-how

• Location advantage: the FDI destination local market must

offer factors (land, capital, know-how, cost/quality of labor, economies of scale) such that it is advantageous for the firm

to locate its investment there (link to trade theory)

• Internalization advantage: transaction costs of an

arms-length relationship licensing, exports higher than managing the activity within the MNE’s boundaries

Dunning, John H (1980) “Towards an eclectic theory of international production:

Some empirical tests.” Journal of International Business Studies 11(2): 9-31

Government Policy and FDI

• The radical view: inbound FDI harmful; MNEs

– Are an instrument of imperialist domination – Exploit host to the advantage of home country – Extract profits from host country; give nothing back – Keep LDCs backward/dependent for investment, technology and jobs

• The free market view: FDI should be encouraged

– Adam Smith, Ricardo, et al: international production should be distributed according to comparative advantage

– The MNE increases the world economy efficiency because it brings to bear unique ownership advantages on the local

Host Country Effects of FDI

• Benefits

– Resource -transfer – Employment

– Balance-of-payment (BOP)

• Import substitution

• Source of export increase

• Costs

– Adverse effects on the BOP

• Capital inflow followed by capital outflow + profits

• Production input importation

– Threat to national sovereignty and autonomy

• Loss of economic independence

Home Country Effects of FDI

• Benefits

– BOP current account adversely affected by inward flow

of foreign earnings – Positive employment effect from increased exports of raw materials / assemblies to the overseas subsidiary – Repatriation of skills and know-how

• Costs

– BOP trade position is negatively affected (lower finished goods exports)

– Loss of employment to overseas market

Government Policy and FDI

• Home country

– Outward FDI encouragement

• Risk reduction policies (financing, insurance, tax incentives)

– Outward FDI restrictions

• National security, BOP

• Host country

– Inward FDI encouragement

• Investment incentives

• Job creation incentives

– Inward FDI restrictions

• Ownership extent restrictions (national security; local nationals can safeguard host country’s interests

Decision Framework for FDI

Are transportation costs

high?

Is know-how easy to

license?

Tight control over foreign ops required?

Is know-how valuable and

is protection possible?

Export

FDI

FDI

FDI

No No

Yes

Yes

No

Yes

Yes

Import Barriers?

No

Yes