Chapter 8 - Foreign Direct Investment

What does FDI mean for international businesses?

The theory of FDI has implications for strategic behavior of firms Government policy on FDI can also be important for international businesses

Gross fixed capital formation

The total amount of capital invested in factories, stores, office buildings. The greater the capital investment in an economy, the more favorable its future prospects are likely to be

flow of FDI

amount of FDI undertaken over a given time period

Location-specific advantages

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

Limitations of Exporting

exporting strategy can be limited by transportation costs and trade barriers -When transportation costs are high, exporting can be unprofitable -Foreign direct investment may be a response to actual or threatened trade barriers such as import tariffs or quotas

Outflows of FDI

flows of FDI out of a country

Licensing

granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit that the foreign entity sells

International trade theory

home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid

oligopolistic industries

industries composed of a limited number of large firms

The free market view

international production should be distributed among countries according to the theory of comparative advantage. Countries should specialize in the production of goods and services they can produce most efficiently. The MNE increases the overall efficiency of the world economy

Externalities

knowledge spillovers that occur when companies in the same industry locate in the same area

Exporting

producing goods at home and then shipping them to the receiving country for sale

current account

records a country's export and import of goods and services

balance-of-payments account

records a country's payments to and receipts from other countries

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

Inflows of FDI

the flows of FDI into a country

stock of FDI

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

Foreign direct investment (FDI)

when a firm invests directly in new facilities to produce or market in a foreign country

multipoint competition

when two or more enterprises encounter each other in different regional markets, national markets, or industries

Limitations of Licensing

1. Licensing could result in a firm giving away valuable technological know-how to a potential foreign competitor 2. Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability 3. Licensing may be difficult if the firm's competitive advantage is not amendable to it and is based on its management, marketing, and manufacturing capabilities

Resource Transfer Effects

FDI can bring capital, technology, and management resources that would otherwise not be available

Employment Effects

FDI can bring jobs that would otherwise not be created there

pragmatic nationalist view

FDI has benefits and costs

Effect on Competition and Economic Growth

FDI in the form of greenfield investment: Increases the level of competition in a market Drives down prices Improves the welfare of consumers Increased competition can lead to: Increased productivity growth Product and process innovation Greater economic growth

Advantages of Foreign Direct Investment

FDI will be favored over exporting when: Transportation costs are high Trade barriers are high FDI will be favored over licensing when: The firm wants control over its technological know-how The firm wants control over its operations and business strategy The firm's capabilities are not amenable to licensing

The Product Life Cycle

Firms invest in other advanced countries when local demand in those countries grows large enough to support local production Firms shift production to low-cost developing countries when product standardization and market saturation create price competition and cost pressures

Restricting Inward FDI

Ownership restraints - exclude foreign firms from certain sectors on the grounds of national security or competition Local owners can help to maximize the resource transfer and employment benefits of FDI Performance requirements - used to maximize the benefits and minimize the costs of FDI for the host country

A firm's bargaining power with the host government is highest when:

The host government places a high value on what the firm has to offer When there are few comparable alternatives available When the firm has a long time to negotiate

a multinational enterprise

A firm engaged in FDI

two forms of FDI

A greenfield investment - the establishment of a wholly new operation in a foreign country Acquisition or merging with an existing firm in the foreign country

1. Encouraging Inward FDI

Governments offer incentives to foreign firms to invest in their countries Motivated by a desire to gain from the resource-transfer and employment effects of FDI, and to capture FDI away from other potential host countries