Chapter 8: Foreign Direct Investment
how does government influence FDI
governments can encourage outward FDI by providing "government backed insurance" programs to cover major types of foreign investment risk governments can restrict outward FDI by: limiting capital outflows, manipulating tax rules, prohibiting FDI
why would gov't restrict?
risk! : gov't backed programs that cover the major forms of risk like from war loss, special loan programs, tax incentives - ownership restraints & performance requirements --> keep foreign firms out of certain industries on grounds of national security // maximize resource transfer & employment benefits
what is the source of FDI
since WWII the US has been the largest country for FDI - the UK, Netherlands, France, Germany & Japan are other important source countries - together these countries account for 60% of all FDI outflows
product life cycle
suggests that firms will change their strategy as a product moves through life cycle - forms would invest in other developed countries when local demand justifies local productions and when it was more standardized it would shift to lesser developed location to take advantage of low cost labor
Flow of FDI
the amount of FDI undertaken over a given time period
Greenfield Investments
the establishment of a wholly new operation in a foreign country --> Nissan & Mercedes Benz in the US
fill in gaps of other theory on why investing preferential to exporting: ECLECTIC THEORY
there are location specific factors and externalities that make FDI preferable -location specific advantage: refers to the advantages that come from using resources or assets that are tied to a specific location that a firm finds valuable to combine with its own assets -externalities: knowledge spill-overs that occur when companies from the same industry locate in the same area {low cost labor?: firms seeking that will go there, natural resources?: go where the oil is located}
stock of FDI
total accumulated value of foreign-owned assets at a given time
Why increase in FDI outflows
1) firms worry about protectionist measures & see FDI as a way of getting around them 2) changes in economic and political policies of many countries have opened them up for investments {eastern Europe} -->deregulation, privatization & few restriction on FDI 3) many firms see the world as their market now, and so are expanding wherever they feel it makes sense /// globalization 4) new bilateral investment treaties {designed to facilitate investment} --> many manufacturers are expanding into foreign countries to take advantage of lower cost labor or to be closer to customers {China = low wage rates & large market}
FDI can be in the form of...
1) greenfield investments 2) acquisitions or mergers - w. existing firms
Licensing Limitations // Internalization Theory
1. Firm could give away valuable technological know-how to a potential foreign competitor -RCA & color tv 2. Does not give a firm the control over manufacturing, marketing, and strategy in the foreign country - the firm doesn't have ability to set prices, market aggressively {mercy of the licensee} 3. Firm's competitive advantage may be based on its management, marketing, and manufacturing capabilities - Toyota // can't translate that know-how over
How does a government's attitude affect FDI
1. Radical View 2. Free Market View 3. Pragmatic Nationalism
What are the costs of FDI to the host country
1. adverse effects of FDI on competition within the host nation ---> host gov't, particularly those of developing countries, worry that the subsidiaries of foreign MNE's might end up having greater economic power & drive local companies out of business 2. adverse effects on the balance of payments --> host countries worry that along with the capital inflows that come with the FDI, will be capital outflows that occur when the subsidiary repatriates profits to parent company - limit amount profits -host countries are also concerned that some subsidiaries import a substantial number of their inputs {will show up on the balance of payments} : some countries pledge to buy locally 3. The loss of national sovereignty & autonomy that is often associated with FDI - sometimes host gov't worry that they may lose some economic independence as a result of FDI - they worry that since foreign companies have no particular commitment, they won't worry about the consequences
What are the costs of FDI to the home country?
1. balance of payments can suffer - initial capital outflow required to finance FDI -if the purpose of the FDI is to serve the home market from a low cost labor location - if the FDI is a substitute for direct exports 2. employment may also be negatively affected if the FDI is a substitute for domestic production
Exporting Limitations
1. exports can be limited by transportation costs and trade barriers - soft drinks expensive to ship long distance 2. FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas - Japanese auto producers found it was easier to set up shop in the US b/c protectionist threats
How does FDI benefit the host country // 4 main benefits
1. resource transfer effects - FDI brings capital, tech, & mgmt resource 2. employment effects - FDI can bring jobs 3. Balance of payment effects -FDI can help a country to achieve a current account surplus 4. Effects on competition & economic growth - greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers --> can lead to increased productivity growth, product and process innovation, and greater economic growth
Why did radical view lacked support by the end of the 1980s because of ...
1. the collapse of communism in Eastern Europe 2. poor economic performance of those countries that followed the policy 3. a growing belief by many of these countries that FDI can be an important source of tech & jobs and can stimulate economic growth 4. the strong economic performance of developing countries that embraces capitalism rather than ideology
How can FDI benefit the home country? {Walmart in China can benefit the US}
1. the effect on the capital account of the home country's balance of payments from the inward flow of foreign earnings 2. employment effect that arise from outward FDI 3. the gains from learning valuable skills from foreign markets that can be subsequently transferred back from home country
The shift to services is being driven by 4 main reasons...
1. there is a general trend in developed countries away from manufacturing & towards services 2. Because services often have to be produced where they are consumed. FDI is required {can't ship a hot latte} 3. There is a liberalization of policies governing services {Brazil recently opened up telecommunications sector} 4. Internet-based global telecommunications now allow companies to shift activities {call centers to low cost locations}
Example of China in FDI
China attracted $60 billion in FDI - China is attractive because high tariffs make it diff to conduct business which make it diff to export, so firms turn to FDI China established many incentives to would- be investors
Pragmatic Nationalism
argues that FDI has both benefits and costs - benefits: inflows of capital, tech, skills and jobs - costs: repatriation of profits and negative balance of payments effects ONLY BE ALLOWED IF BENEFITS OUTWEIGH THE COSTS
Radical View
argues that MNE is an instrument of imperialist domination and a means of exploiting host countries for the benefit of their capitalist-imperialist home countries - believe MNE will fill all important jobs with home country citizens, leaving the host nation dependent on capitalist country for investment, job & tech {radical stance has been in retreat as countries embraces capitalism, more successful economically}
Free Market View
argues that international production should be distributed among countries according to the theory of comparative advantage - suggests that countries specialize in the production of the goods they can produce most efficiently and trade for everything else. It then follows, that FDI will actually increase the overall efficiency of the global economy {Ford moved plants to Mexico b/c of low labor costs, Ford is transferring tech, skills and capital} -Adam Smith & David Ricardo {while no country has fully adopted the pure free market stance, this ideology has been embraces by many developed nations - US, Hong Kong & Chile}
why do firms chose acquisition versus greenfield investments?
b/c... -mergers & acquisition are QUICKER to execute than greenfield investments - it is easier and perhaps LESS RISKY for a firm to acquire desired assets than build them from the ground up - firms believe that they can INCREASE EFFICIENCY of an acquired unit by TRANSFERRING CAPITAL, TECH or management skills {when developing country is targets for FDI flows, mergers are much less common b/c the there are fewer firms - between 40-80% of all FDI inflows per annum from 1998 to 2011 were in form of mergers but in developing countries 2/3 of investment were greenfiels
Patterns of FDI...
both the flow & stock of FDI have increased over the last 35 years --> most FDI is targeted towards developed nations {US, Japan, EU} BUT other destinations are emerging {South, East, & South East Asia especially China, Latin America}
Inflow of FDI
flows of FDI into a country
Outflow of FDI
flows of FDI out of a country
Licensing
involves 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
Exporting
involves producing goods at home and then shipping it to the receiving country for sale
what trends in FDI can we see over the last thirty years or so?
marked increase in both the flow and stock of FDI in the world economy --> in 1975 = $25 billion but by 2008 it was $1.4 billion UPWARD PATTERN
Foreign Direct Investment
occurs when a firm invests directly in new facilities to produce and/or market in a foreign country --> becomes a multinational enterprise
multipoint competition
occurs when two or more companies encounter each other in different markets - forms will try match each other's moves as a way of keeping each other in check {Kodak & Fuji do this: if Kodak enters the market so will Fuji}
encourage FDI?
offer incentives like tax breaks, low interest loans or subsidies
Why do firms in the same industry often make investments at about the same time and tend to direct their investments towards certain locations
one theory: FDI FLOWS REFLECT STRATEGIC RIVALRY BETWEEN FIRMS knickerbocker explored the relationship between FDI and rivalry in OLIGOPOLISTIC industries { composed of limited number of large firms} - these industries are unique b/c what one company does can have an immediate effect on other firms, forcing them to take similar actions {Airline industry: if one airline cuts prices on certain routes, you see other airlines do the same}
Gross Fixed Capital
total amount of capital invested in factories, stores, office buildings {in %} --> the greater the capital invested in an economy, the more favorable its future prospects are likely to be be * important source of capital investment which can be factor int eh future growth rate of an economy
