Chapter 8 International Business

Host-Country Costs in FDI

Adverse Effects on Competition

JCB in India

British manufacturer JCB entered a joint venture with Indian engineering conglomerate Escorts in 1979. • Government regulations and high tariffs spurred the action. • JCB looked to gain an advantage over global competitors. In 1999, JCB renegotiated terms with Escorts to take advantage of changes in government regulations. • Joint venture became a wholly owned subsidiary. • Soon expanded into the U.S., Brazil, and then China. By 2008, JCB's foreign investment was bearing fruit.

The Eclectic Paradigm

Dunning's eclectic paradigm: in addition to the previous factors, two additional factors must be considered when explaining both the rationale for and the direction of foreign direct investment.

Host-Country Benefits of FDI Resource-Transfer Effects:

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

Host-Country Benefits of FDI Employment Effects

FDI can bring jobs that would otherwise not be created there. Opponents say not all "new jobs" represent net additions in employment.

Home-Country Costs Balance-of-payments effects Current account suffers if the

FDI is a substitute for direct exports.

MNE Has been in retreat since the 1990s due to

Has been in retreat since the 1990s due to: • Collapse of communism in Eastern Europe. • Poor economic performance of countries that embraced the policy. • Strong economic performance of developing countries that embraced capitalism.

_____________________ is needed to explain why firms prefer FDI to licensing or exporting.

Internalization theory

The Radical View

MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalistimperialist home countries Still lingers in some countries, such as Venezuela.

The WTO has had some success in establishing

a universal set of rules to promote the liberalization of FDI

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

Home Country Benefits of FDI Gains from learning valuable skills from foreign markets that can subsequently

be transferred back to the home country

Until recently, there has been no _______________________ by multinational institutions in the governing of FDI. What changed this?

consistent involvement The WTO in 1995

Historically, most FDI has been directed at

developed nations. • United States and European Union are favorite targets.

Greenfield investments

establishing new operations in a foreign country

Foreign direct investment may be both _____________ compared with exporting and licensing

expensive and risky

Home-Country Costs Employment effects. If the home country is suffering from unemployment, there may be concern about the ________ of jobs.

export

Shifting Ideology In recent years, there has been a strong shift toward the

free market stance.

FDI may actually stimulate economic growth by

freeing home country resources to concentrate on activities where the home country has a comparative advantage

Licensing

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

Host-Country Costs Adverse Effects on Competition Subsidiaries of foreign MNEs may have::

greater economic power than indigenous competitors because they may be part of a larger international organization

Host-Country Costs, Possible Effects on National Sovereignty and Autonomy FDI can mean some loss of economic _____________.

independence

Host-Country Costs Adverse Effects on Competition Could allow the MNE to drive ________________ out of the market and create a __________________.

indigenous competitors monopoly position

Knickerbocker explored the relationship between FDI and rivalry in oligopolistic industries

industries composed of a limited number of large firms. • FDI flows reflect strategic rivalry between firms

Home-Country Costs Balance-of-payments effects Suffers from the ____________ required to finance the FDI.

initial capital outflow

Externalities

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

The________________________________ argument associated with Dunning help explain the direction of FDI.

location-specific advantages

Host-Country Costs of FDI Possible Effects on National Sovereignty and Autonomy Key decisions that can affect the host country's economy will be made by a foreign parent that has:

no real commitment to the host country, and over which the host country's government has no real control

Exporting

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

Host-Country Costs Adverse Effects on Competition MNE could draw on funds generated elsewhere to ____________ costs in the local market

subsidize

Agreements in WTO reached in 1997 for liberalization of trade in

telecommunications and financial services

Home Country Benefits of FDI Positive employment effects

that arise from outward FDI

Home-Country Costs Balance-of-payments effects Current account is negatively affected if

the FDI is to serve the home market from a lowcost production location

Inflows of FDI:

the flows of FDI into a country

Outflows of FDI

the flows of FDI out of a country

Home Country Benefits of FDI The effect on the home country's balance of payments from:

the inward flow of foreign earnings

FDI should be allowed only if benefits outweigh the costs. Tendency to aggressively court FDI believed

to be in the national interest by offering subsidies. • Also seen in competition between individual states in the U.S.

Stock of FDI

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

Exporting is preferable to licensing and FDI if

transportation costs and trade barriers are low

This theory can be extended to multipoint competition

when two or more enterprises encounter each other in different regional markets, national markets, or industries. • Firms will try to match other's moves in different markets to try to hold each other in check.

Foreign Direct Investment (FDI)

• A firm invests directly in new facilities to produce or market in a foreign country. • According to U.S. Department of Commerce, FDI occurs when there is a 10 percent interest taken in a foreign business entity. • A firm engaged in FDI is a multinational enterprise.

a strong shift toward free market stance caused

• A surge in the volume of FDI worldwide. • An increase in the volume of FDI directed at countries that have recently liberalized their regimes—China, India, Vietnam. Countries like Venezuela and Bolivia are becoming more hostile to FDI.

Pragmatic Nationalism FDI has benefits and costs

• Benefits: inflows of capital, technology, skills, and jobs. • Costs: repatriation of profits to the home country, a negative balance of payments effect.

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. • FDI by the MNE increases the overall efficiency of the world economy.

More recently, developing nations have been recipients of FDI.

• Eastern Europe and Southeast Asia—particularly China—have received significant inflows. • Latin America is also emerging as an important region for FDI. • China is becoming a major investor in Africa, especially in the extraction industries

Host-Country Policies Restricting Inward FDI. Ownership restraints

• Exclude foreign firms from certain sectors on the grounds of national security or competition. • Local owners can help maximize the resource-transfer and employment benefits of FDI

Limitations of Exporting

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

Trends in FDI Both the flow and stock of FDI in the world economy have increased over the last 30 years. FDI flow has grown more rapidly than world trade and world output.

• Firms still fear protectionist policies. • The shift toward democratic political institutions and free market economies encourages FDI. • Globalization prompts firms to have a significant presence in many regions of the world.

Governments offer incentives to foreign firms to invest in their countries

• Gain from the resource-transfer and employment effects of FDI. • Capture FDI away from other potential host countries

Host-Country Policies Encouraging Inward FDI

• Governments offer incentives to foreign firms to invest in their countries • In the United States, state governments often compete to attract FDI

Home-Country Policies Encouraging Outward FDI

• Have government-backed insurance programs to cover major types of foreign investment risk. • Have special funds or banks that make governmental loans to firms investing in developing countries. • Eliminate double taxation of foreign income. • Many host nations have relaxed restrictions on inbound FDI.

Political Ideology

• Ideology toward FDI has ranged from a radical stance that is hostile to all FDI to the noninterventionist principle of free market economies. • Between these two extremes is an approach called pragmatic nationalism.

Host-Country Benefits of FDI Effect on Competition and Economic Growth. Increased competition leads to:

• Increased productivity growth. • Product and process innovation. • Greater economic growth.

Host-Country Benefits of FDI 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.

FDI can help achieve a current account surplus if:

• It is a substitute for imports of goods and services. • The MNE uses a foreign subsidiary to export goods and services to other countries

Internalization theory (or market imperfections approach)

• Licensing could result in a firm's giving away valuable technological knowhow to a potential foreign competitor. • 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 if the firm's competitive advantage is not amenable to it

Countries may restrict firms from investing in certain nations for political reasons.

• Restrictions may be formal or informal. • Cuba and Iran, South Africa

The Source of FDI

• Since World War II, the U.S. has been the largest source country for FDI. • Other important source countries: United Kingdom, Netherlands, France, Germany, and Japan. • Chinese firms recently emerging as major foreign investors

Host-Country Benefits of FDI 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

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.

Licensing is unattractive when

• The firm's proprietary property cannot be properly protected by a licensing agreement. • The firm needs tight control over a foreign entity in order to maximize its market share and earnings in that country. • The firm's skills and capabilities are not amenable to licensing.

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. • There are few comparable alternatives available. • The firm has a long time to negotiate

Acquisitions are attractive because

• They are quicker to execute than greenfield investments. • 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

FDI will be favored over exporting when

• Transportation costs are high. • Trade barriers are high.

Host-Country Policies Restricting Inward FDI Performance requirements:

• Used to maximize the benefits and minimize the costs of FDI for the host country. • Tend to be more common in less developed countries than in advanced industrialized nations.

Home-Country Policies continued Restricting Outward FDI

• Virtually all investor countries, including the U.S., have exercised some control over outward FDI periodically. • 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. • Restrictions may be formal or informal. • Cuba and Iran, South Africa

Three Complementary Perspectives

• Why does a firm favor direct investment over exporting and licensing? • Why do firms in the same industry undertake foreign direct investment at the same time and favor certain locations as targets for FDI? • Eclectic paradigm combines these two perspectives.