International Business - Chapter 7

Globalization of the world economy encourages

firms to use FDI as a way to create low-cost production bases. It also prompts multinationals from advanced and emerging economies alike to buy up businesses in other markets.

Home countries may promote outward FDI because:

FDI outflows can improve long-run competitiveness if partnering abroad provides a learning opportunity. And FDI outflows can help export jobs in industries that use obsolete technology or employ low-wage, low-skilled workers at home.

To restrict FDI outflows, home countries can:

Impose a higher tax rate on income earned abroad than that levied on domestic earnings. And impose sanctions that prohibit domestic firms from making investments in certain nations.

Home countries may discourage outward FDI for several reasons:

Investing in other nations sends resources out of the home country and lowers investment at home. An FDI outflow can damage a nation's balance of payments if the investment abroad eliminates an export market. And jobs created abroad by an FDI outflow may replace jobs in the home country.

Mergers and acquisitions have

Mergers and acquisitions have propelled long-term growth in FDI and will likely do so for the foreseeable future.

To promote FDI outflows, home nations can:

Offer insurance to cover the risks of investing assets abroad. Grant loans to firms wishing to increase their investments abroad. Offer tax breaks on profits earned abroad or negotiate special tax treaties. And apply political pressure to get other nations to relax their restrictions on FDI inflows.

Other methods to restrict FDI inflows include

performance demands. Such demands can dictate the portion of a product's content that originates locally, stipulate that a portion of output must be exported, or demand that certain technologies be transferred to local businesses.

The practice of following rivals resembles a "follow the leader" scenario and is common in industries with a limited number of large firms.

The force behind FDI is a belief that not matching rivals' moves means the loss of a "first mover" advantage or being shut out of a lucrative market altogether.

One type of market imperfection is

a trade barrier, such as a tariff.

One method host countries can use to promote FDI inflows are

financial incentives. Tax incentives and/or low-interest loans to attract investment are common incentives. But if bidding wars arise between locations competing for the investment, the cost of the FDI for taxpayers may be more than what the actual jobs will pay.

Portfolio investment, which is

an investment that does not involve obtaining a degree of control in a company

Knowledge of customer and buyer behavior can

be a key issue in the decision of whether to undertake FDI.

By contrast, a host country conserves its foreign exchange reserves when

foreign companies reinvest earnings locally. This boosts the host nation's exports and improves its balance-of-payments position.

The benefit of market power is increased profits because

greater power helps a firm to dictate the cost of its inputs and/or the price of its output.

Many companies invest abroad to

increase their control over factors such as selling price in a local market. But a host nation may demand shared ownership in an operation.

One main driver behind global flows of foreign direct investment is

increasing globalization

Other methods to promote FDI inflows include

infrastructure improvements. Lasting benefits for communities in the host nation can arise from local infrastructure improvements—including better seaports for containerized shipping, improved roads, and advanced telecommunications systems.

Host countries get a balance-of-payments boost from

initial FDI inflows. The balance-of-payments position benefits further if that investment produces goods destined for export.

Another diver behind global flows of foregone direct investment is

international mergers and acquisitions.

When a company repatriates profits back to its home market,

it depletes the host nation's foreign exchange reserves and decreases the balance of payments. This entices some host nations to restrict foreign firms from repatriating profits.

Host countries also intervene in foreign direct investments to

obtain resources and benefits.

One method host countries can use to restrict FDI inflows are

ownership restrictions. Governments can prohibit foreign companies from investing in certain industries or owning certain types of businesses. They may also require foreign investors to hold less than a 50% stake in a local firm.

Most governments set the FDI threshold at

somewhere between 10 and 25 percent of stock ownership in a company abroad.

The practice of following clients into markets abroad typically occurs when

suppliers of component parts have close working relationships with their customers. An FDI puts the supplier nearer to their customers where they can better understand and anticipate their needs.

market power theory states

that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment.

The market imperfections (or internalization) theory states

that when an imperfection in the market makes a transaction less efficient than it could be, a company will undertake FDI to internalize the transaction and thereby eliminate the imperfection.

Companies can gain market power through vertical integration—

the extension of activities into production that provide a firm's inputs or absorb its output.

Foreign direct investment is

the purchase of physical assets or a significant amount of the ownership of a company in another country to gain some measure of management control.

Another type of imperfection is a company's

unique competitive advantage, such as specialized knowledge, technical expertise, or special abilities embodied in employees

Rationalized production

whereby each component is produced where its production cost is lowest, can be problematic if a work stoppage in one country can halt the entire production process.

The purchase-or-build decision entails deciding

whether to purchase an existing business or to build a subsidiary from the ground up—called a greenfield investment.

Production costs that add to local labor costs include

worker benefits, training programs, and burdensome regulations.