Foreign Direct Investment (FDI)

International trade theory

home country concerns about the negative economic effects of offshore production

Limitations of Licensing

"Internalization Theory" suggests Licensing could result in a firm's giving away valuable technological know-how to a potential foreign competitor (i.e., RCA; Matsushita and Sony) 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 Licensing may be difficult or ineffective if the firm's competitive advantage is not suited to it If it's based on management, marketing & manufacturing expertise vs technology-based.

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

Trends in FDI

-Both the flow and stock of FDI in the world economy have increased over the last 35 years -FDI has grown more rapidly than world trade and world output -Historically, most FDI has been directed at the developed nations of the world(Favorite targets: United States and European Union) -More recently, developing nations have been the recipients of FDI.

Limitations of Exporting

-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

Alternatives to FDI

1. Exporting - producing goods at home and then shipping them to the receiving country for sale 2. 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

Host Country Encouraging Inward FDI

1. 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 -Also to capture FDI away from other potential host countries -Tax concessions, low-interest loans, grants, subsidies are common tools to help attract FDI.

Home Country Encouraging Outward FDI

1. Many nations : -Have government-backed insurance programs to cover major types of foreign investment risk -Have eliminated double taxation of foreign income 2. Many host nations have relaxed restrictions on inbound FDI due to home country pressures -Example: 1980's - Japan pressured by US & relaxed barriers to inward FDI

Host Country Restricting Inward FDI

1. 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

Host Country Partial Restraints

1. Prohibit wholly-foreign-owned companies - Joint Ventures OK 2. Performance requirements - used to maximize the benefits and minimize the costs of FDI for the host country

Host Country Benefits from FDI

1. Resource Transfer Effects -FDI can bring capital, technology, and management resources that would otherwise not be available 2. Employment Effects -FDI can bring jobs that would otherwise not be created there 3. Balance-of-Payments Effects -The balance-of-payments account records a country's payments to and receipts from other countries -The current account records a country's export and import of goods and services -A surplus is usually favored over a deficit -FDI can help achieve a current account surplus: -If it is a substitute for imports of goods and services -If the MNE uses a foreign subsidiary to export goods and services to other countries 4. 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

Home Country Costs

1. The balance-of-payments -The balance of payments suffers from the initial capital outflow required to finance the FDI -The current account is negatively affected if the purpose of the FDI is to serve the home market from a low-cost production location -The current account suffers if the FDI is a substitute for direct exports 2. Employment effects of outward FDI -If the home country is suffering from unemployment, there may be concern about the export of jobs

Home Country Benefits

1. The effect on the capital account of the home country's balance of payments from the inward flow of foreign earnings 2. The employment effects that arise from outward FDI (increased demand for components, for example) 3.The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country

Home Country Restricting Outward FDI

1. Virtually all investor countries, including the United States, have exercised some control over outward FDI from time to time -Countries manipulate tax rules to make it more favorable for firms to invest at home -Countries may restrict firms from investing in certain nations for political reasons

Advantages of FDI

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 -wants control over its operations and business strategy -has key capabilities that are not amenable to licensing

Most Common form of FDI

Most cross-border investment involves mergers and acquisitions. Acquisitions are attractive because: -They are quicker to execute than greenfield investments -It is easier and less risky for a firm to acquire desired assets than build them from the ground up -Firms believe they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

Foreign Direct Investment (FDI)

Occurs when a firm invests directly in a new facilities to produce or market in a foreign country. Multinational enterprise is a firm engaged in____ .

Flow of FDI

The amount of FDI undertaken over a given time period

Inflows of FDI

The flows of FDI into a country

Outflows of FDI

The flows of FDI out of a country

Stock of FDI

The total accumulated value of foreign-owned asset at a given time.