Chapter 7 Foreign Direct Investment

portfolio investment

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

rationalized production

production in which each of a product's components is produced where the most of producing that component is lowest.

international product life cycle

theory stating that a company begins by exporting its product and then later undertakes foreign direct investment as the product moves through its life cycle

current account surplus

when a country exports more goods and services and receives more income from abroad than it imports and pays abroad

current account deficit

when a country imports more goods and services and pays more abroad than it exports and receives from abroad

Explain why governments intervene in FDI

A balance of payments is a national accounting system that records all payments to entities in other countries and all receipts coming into the nation. Control Balance of Payments: Many governments see intervention as the only way to keep their balance of payments under control. Obtain Resources and Benefits: Beyond balance-of-payments reasons, governments might intervene in FDI flows to acquire resources and benefits such as technology, management skills, and employment. -Access to Technology -Management Skills and Employment 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. Home countries may also promote outward FDI. FDI outflows can improve long-run competitiveness if partnering abroad provides a learning opportunity. FDI outflows can eliminate low-wage jobs in industries that use obsolete technology or employ low-skilled workers at home.

balance of payments

A national accounting system that records all payments to entities in other countries and all receipts coming into a nation. It consists of the current and capital account.

Outline the important management issues in the FDI devision

Control: Many companies investing abroad are greatly concerned with controlling the activities that occur in the local market. Purchase-or-Build Decision: Another important matter for managers is whether to purchase an existing business or to build a subsidiary abroad from the ground up—called a greenfield investment. Production costs are important inputs to the FDI decision. -One approach companies use to contain production costs is called rationalized production—a system of production in which each of a product's components is produced where the cost of producing that component is lowest. -Mexico's Maquiladora: The combination of a low-wage economy nestled next to a prosperous giant is now becoming a model for other regions that are split by wage or technology gaps. -Cost of Research and Development : As technology becomes an increasingly powerful competitive factor, the soaring cost of developing subsequent stages of technology has led multinational corporations to engage in cross-border alliances and acquisitions. Customer Knowledge: The behavior of buyers is frequently an important issue in the decision of whether to undertake FDI. Following Clients: Firms commonly engage in FDI when the firms they supply have already invested abroad. Following Rivals: FDI decisions frequently resemble a "follow the leader" scenario in industries that have a limited number of large firms. In other words, many of these firms believe that choosing not to make a move parallel to that of the "first mover" might result in being shut out of a potentially lucrative market.

Describe policy instruments governments use to promote and restrict FDI.

Host countries offer a variety of incentives to encourage FDI inflows. These take two general forms—financial incentives and infrastructure improvements. -Financial Incentives: Host governments of all nations grant companies financial incentives to invest within their borders. One method includes tax incentives, such as lower tax rates or offers to waive taxes on local profits for a period of time—extending as far out as five years or more. A country may also offer low-interest loans to investors. -Infrastructure Improvements: Because of the problems associated with financial incentives, some governments are taking an alternative route to luring investment. Lasting benefits for communities surrounding the investment location can result from making local infrastructure improvements—better seaports suitable for containerized shipping, improved roads, and advanced telecommunications systems. Host countries also have a variety of methods to restrict incoming FDI. Again, these take two general forms—ownership restrictions and performance demands. -Ownership Restrictions: Governments can impose ownership restrictions that prohibit nondomestic companies from investing in certain industries or from owning certain types of businesses. -Performance Demands: More common than ownership requirements are performance demands that influence how international companies operate in the host nation. To encourage outbound FDI, home-country governments can do any of the following: -Offer insurance to cover the risks of investments abroad, including, among others, insurance against expropriation of assets and losses from armed conflict, kidnappings, and terrorist attacks. -Grant loans to firms wishing to increase their investments abroad. -Offer tax breaks on profits earned abroad or negotiate special tax treaties. -Apply political pressure on other nations to get them to relax their restrictions on inbound investments. On the other hand, to limit the effects of outbound FDI on the national economy, home governments may exercise either of the following two options: -Impose differential tax rates that charge income from earnings abroad at a higher rate than domestic earnings. -Impose outright sanctions that prohibit domestic firms from making investments in certain nations.

Describe the worldwide pattern of foreign direct investment.

In 2012, for the first time ever, developing countries attracted greater FDI inflows than did developed countries. Among developed countries, the EU, US and Japan account for the majority of FDI inflows. Developed countries account for 42 percent ($561 billion) of total global FDI inflows (more than $1.35 trillion in 2012). By comparison, FDI inflows to developing countries accounted for around 52 percent of world FDI inflows ($703 billion). The remaining roughly six percent of global FDI inflows went to countries across Southeast Europe in various stages of transition from communism to capitalism. Drivers of FDI Flows -Globalization -Mergers and Acquisitions

current account

Records transactions involving the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country.

capital account

Records transactions involving the purchase or sale of assets.

market power

States that a firm tries to establish a dominant market presence in an industry by undertaking FDI.

eclectic theory

States that firms undertake FDI when the features of a particular location combined with ownership and internalization advantages to make a location appealing for investment.

market imperfections

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

vertical integration

extension of company activities into stages of production that provides a firms input or that absorbs its output

Summarize each theory that attempts to explain why FDI occurs.

The international product life cycle theory states that a company begins by exporting its product and then later undertakes FDI as a product moves through its life cycle. The market power theory states that a firm tries to establish a dominant market presence in an industry by undertaking FDI. Eclectic theory states that firms undertake FDI when the features of a particular location combined with ownership and internalization advantages to make a location appealing for investment. Market imperfections theory states that, when an imperfection in the market makes a transaction less efficient that it could be, a company will undertake FDI to internalize the transaction and thereby remove the imperfection.

foreign direct investment

The purchase of physical assets or significant amount of the ownership of a company in another country to gain a measure of management control. The US Department of Commerce sets the threshold at 10% of stock ownership.