Foreign Direct Investment
Inward FDI has three main costs to the host country
1.Adverse effects of FDI on competition within the host nation Subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization 2.Adverse effects on the balance of payments When a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country's balance of payments 3.Perceived loss of national sovereignty and autonomy Decisions that affect the host country 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
four main benefits of inward FDI for a host country
1.Resource transfer effects 2.Employment effects 3.Balance of payments effects 4.Effects on competition and economic growth
The benefits of FDI for the home country include
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 3.The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
Costs Of FDI To The Home Country
1.The home country's balance of payments can suffer 2.Employment may also be negatively affected if the FDI is a substitute for domestic production
Recently, there has been a strong shift toward the free market stance creating
A surge in FDI worldwide An increase in the volume of FDI in countries with newly liberalized regimes
Patterns of FDI
Both the flow and stock of FDI have increased over the last 30 years Most FDI is targeted towards developed nations -United States and EU South, East, and South East Asia -China -and Latin America are emerging FDI has grown more rapidly than world trade and world output Firms still fear the threat of protectionism Democratic political institutions and free market economies have encouraged FDI Globalization is forcing firms to maintain a presence around the world
free market view is
Embraced by advanced and developing nations including the United States, Britain, Chile, and Hong Kong
Why Choose FDI
Exporting, Licensing, Internalization theory
Exporting cont.
Exports can be limited by transportation costs and trade barriers FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas
Resource transfer effects
FDI brings capital, technology, and management resources
Employment effects
FDI can bring jobs
Balance of Payments effects
FDI can help a country to achieve a current account surplus
Knickerbocker
FDI flows are a reflection of strategic rivalry between firms in the global marketplace (e.g., airline industry)
Pragmatic nationalism view to FDI
FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect)
Why Does FDI In Services Occur
FDI is shifting away from extractive industries and manufacturing, and towards services
3 major drawbacks of licensing
Firm could give away valuable technological know-how to a potential foreign competitor Does not give a firm the control over manufacturing, marketing, and strategy in the foreign country The firm's competitive advantage may be based on its management, marketing, and manufacturing capabilities
Governments can encourage outward FDI
Government-backed insurance programs to cover major types of foreign investment risk
FDI can be in the form of
Greenfield Investments Acquisitions or mergers with existing firms in the foreign country
Euro Disney in France example
In 1984, Walt Disney Co. announced intentions to build theme park in Europe. France gov saw it as opportunity to boost economy and establish France as major tourist destination after 1980 recession. It would not be private foreign investment but state funded program. France promised $1 billion and Disney also invested. 85% french pop welcomed eurodisney but others caused outrage.
Patterns of FDI
Knickerbocker, Vernon
Governments can restrict outward FDI
Limit capital outflows, manipulate tax rules, or outright prohibit FDI (e.g., US and Cuba and Iran)
Dunning's eclectic paradigm
Location-specific advantages Externalities Dunning's theory is important because it explains how location specific factors affect FDI flows
After FDI, the firm becomes a
MNE
Firms prefer to acquire existing assets because
Mergers and acquisitions 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 the efficiency of an acquired unit by transferring capital, technology, or management skills
Why Do Firms Choose Acquisition Versus Greenfield Investments
Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments
Governments can encourage inward FDI
Offer incentives to foreign firms to invest in their countries Gain from the resource-transfer and employment effects of FDI, and capture FDI away from other potential host countries
Theoretical Approaches To FDI
Radical View Free Market View Pragmatic nationalism
What is the source of FDI
Since World War II, the U.S. has been the largest source country for FDI
Other source countries of FDI
The United Kingdom, the Netherlands, France, Germany, and Japan
The shift to services is being driven by
The general move in many developed countries toward services The fact that many services need to be produced where they are consumed A liberalization of policies governing FDI in services The rise of Internet-based global telecommunications networks
Source countries of FDI
Together, these countries account for 56% of all FDI outflows from 1998-2006, and 61% of the total global stock of FDI in 2007
How Do International Institutions Influence FDI
Until the 1990s, there was no consistent involvement by multinational institutions in the governing of FDI
Governments can restrict inward FDI
Use ownership restraints and performance requirements (e.g., Sweden tobacco industry, Japan until 1980s / only open for valuable technology
FDI is an important source of
capital investment and a determinant of the future growth rate of an economy
Vernon
firms undertake FDI at particular stages in the life cycle of a product
Inflows of FDI
flows of FDI into a country
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
Effects on competition and 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
Free Market View to FDI
international production should be distributed among countries according to the theory of comparative advantage
why is it profitable for firms to undertake FDI rather than continuing to export from home base, or licensing a foreign firm?
it is important to consider
Externalities
knowledge spillovers that occur when companies in the same industry locate in the same area (e.g. Silicon Valley)
Foreign direct investment
occurs when a firm invests directly in new facilities to produce and/or market in a foreign country
Exporting
producing goods at home and then shipping them to the receiving country for sale
flow of FDI
refers to the amount of FDI undertaken over a given time period
Internalization theory
suggests that licensing has three major drawbacks compared to FDI
Location-specific advantages
that 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
Radical View to FDI
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
According to Pragmatic nationalism, FDI should be allowed only if
the benefits outweigh the costs
Greenfield Investments
the establishment of a wholly new operation in a foreign country
stock of FDI
the total accumulated value of foreign-owned assets at a given time
Gross fixed capital formation
the total amount of capital invested in factories, stores, office buildings, and the like The greater the capital investment in an economy, the more favorable its future prospects are likely to be
Multipoint competition
when two or more enterprises encounter each other in different regional markets, national markets, or industries (e.g., Kodak and Fuji)
