Greenfield operation: Mostly in developing nations Mergers and acquisitions: Quicker to execute Foreign firms have valuable strategic assets Believe they can increase the efficiency of the acquired firm More prevalent in developed nations
The answer is c.
The answer is a.
Country Focus: Foreign Direct Investment in China Summary This feature explores investment opportunities in China. In the late 1970s, China opened its doors to foreign investors. By the mid 2000s, China attracted $60 billion of FDI annually. China’s large population is a magnet for many companies and because high tariffs make it difficult to export to the Chinese market, firms frequently turn to foreign direct investment. However, many companies have found it difficult to conduct business in China, and in recent years investment rates have slowed. In response, the Chinese government, hoping to continue to attract foreign companies has established a number of incentives for would-be investors. The following questions can be used in a discussion. 1. Consider the challenges involved with investing in China. How does China’s political position and economic situation affect its ability to attract foreign direct investment? Discussion Points: Students will probably recognize that while on the surface, China has tremendous market potential, it is still a poor country. Anticipated demand does not always translate into actual demand. In addition, thanks to the country’s lack of a well-developed transportation system, distribution problems continue to exist, particularly outside major urban areas. In addition, the country’s highly regulated environment makes it difficult for companies to conduct business. 2. Discuss China’s efforts to encourage investment in its underdeveloped areas. What effect will investment have on these areas? How can firms prepare for the unique challenges of operating in these areas? Discussion Points: China is making a concerted effort to continue to attract investment, especially in the country’s less developed areas. Recognizing the problems associated with its infrastructure, the country has committed $800 billion to improvements over the next decade. In addition, China is offering preferential tax breaks to countries that invest in more remote areas.
This Figure suggests that FDI has become increasingly important as a source of investment in the world’s economies.
The answer is a.
FDI is more attractive when transportation costs or trade barriers make exporting unattractive. A firm will favor FDI over licensing when it wishes to maintain control over its technological know-how, or over its operations and business strategy, or when the firm’s capabilities are simply not amenable to licensing. With regard to horizontal FDI, market imperfections arise in two circumstances: When there are impediments to the free flow of products between nations which decrease the profitability of exporting relative to FDI and licensing When there are impediments to the sale of know-how which increase the profitability of FDI relative to licensing
FDI is expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise. FDI is risky because of the problems associated with doing business in another culture where the rules of the game may be different.
The answer is b.
This position lacked support by the end of the 1980s because of: the collapse of communism in Eastern Europe the poor economic performance of those countries that followed the policy a growing belief by many of these countries that FDI can be an important source of technology and jobs and can stimulate economic growth the strong economic performance of developing countries that embraced capitalism rather than ideology
Management Focus: DP World and the United States Summary This feature explores the reaction to the bid by DP World, a Dubai-based ports operator, to acquire P&O, a British firm that runs a network of global marine terminals. An acquisition of P&O would give DP World management of six U.S. ports. While the Bush administration claimed the acquisition posed no threat to national security, several prominent U.S. Senators raised concerns about the acquisition. Ultimately, DP World pulled out of the deal, but stated that it would look for alternative ways to enter the U.S. market. The following questions can be used in a discussion. Suggested Discussion Questions 1. Do you agree with the senators who raised concerns about the DP World deal? Why or why not? Would your response be different if DP World were a British firm? Discussion Points: This issue will probably generate significant debate among students. At the heart of the issue is whether a company, because of its country of origin, should be denied ownership of something that could be important to a nation’s national security. Some students will probably argue that the U.S. was unjustified in its reaction to the deal, that DP World has a long history of American associations. Students taking this perspective will probably suggest that the U.S. is being prejudiced against the company simply because of its nationality. Other students however, will probably claim that DP World’s role in with American companies to date, has not involved ownership of ports that could be important to the country’s national security. Students in this camp will probably argue that the ports should be owned by American companies, or at least companies from countries that are allies of the United States in order to preserve national security, but definitely not a state-owned company from the Middle East. The implication here is that ownership of the ports would effectively transfer to a foreign government. 2. DP World has vowed to enter the U.S. market in some other way. Why is the U.S. market so important to DP World? What do you think the response of the government might be to another attempt by DP World? Discussion Points: The U.S. market is important to DP World because it is an epicenter of capitalism. Goods from all over the world flow to the United States, and DP World wants to be in a position to capitalize on this. Students will probably agree that should the company make another attempt to gain a foothold in the market, the United States will be reluctant to allow DP World a significant role in the country, especially in major ports.
The answer is d.
The answer is c.
The rationale underlying ownership restraints is twofold: first, foreign firms are often excluded from certain sectors on the grounds of national security or competition second, ownership restraints seem to be based on a belief that local owners can help to maximize the resource transfer and employment benefits of FDI for the host country
7-3IntroductionForeign direct investment (FDI) occurs when a firminvests directly in new facilities to produce and/or market ina foreign countryOnce a firm undertakes FDI it becomes a multinationalenterpriseFDI can be:greenfield investments - the establishment of a whollynew operation in a foreign countryacquisitions or mergers with existing firms in the foreigncountry
7-4Classroom Performance SystemThe establishment of a wholly new operation in a foreigncountry is calledA) an acquisitionB) a mergerC) a greenfield investmentD) a multinational venture
7-5Foreign Direct InvestmentIn The World EconomyThe flow of FDI refers to the amount of FDI undertakenover a given time periodThe stock of FDI refers to the total accumulated value offoreign-owned assets at a given timeOutflows of FDI are the flows of FDI out of a countryInflows of FDI are the flows of FDI into a country
7-6Classroom Performance SystemThe amount of FDI undertaken over a given time period isknown asA) the flow of FDIB) the stock of FDIC) FDI outflowD) FDI inflow
7-7Trends In FDIThere has been a marked increase in both the flow andstock of FDI in the world economy over the last 30 yearsFDI has grown more rapidly than world trade and worldoutput because:firms still fear the threat of protectionismthe general shift toward democratic political institutionsand free market economies has encouraged FDIthe globalization of the world economy is having apositive impact on the volume of FDI as firms undertakeFDI to ensure they have a significant presence in manyregions of the world
7-8Trends In FDIFigure 7.1: FDI Outflows 1982-2006 ($ billions)
7-9The Direction Of FDIMost FDI has historically been directed at the developednations of the world, with the United States being a favoritetargetFDI inflows have remained high during the early 2000sfor the United States, and also for the European UnionSouth, East, and Southeast Asia, and particularly China,are now seeing an increase of FDI inflowsLatin America is also emerging as an important region forFDI
7-10The Direction Of FDIFigure 7.3: FDI Inflows by Region ($ billion), 1995-2006
7-11The Direction Of FDIGross fixed capital formation summarizes the totalamount of capital invested in factories, stores, officebuildings, and the likeAll else being equal, the greater the capital investment inan economy, the more favorable its future prospects arelikely to beSo, FDI can be seen as an important source of capitalinvestment and a determinant of the future growth rate ofan economy
7-12The Direction Of FDIFigure 7.4: Inward FDI as a % of Gross Fixed CapitalFormation 1992-2005
7-13Classroom Performance SystemMost FDI is direct towarda) developed countriesb) emerging economiesc) the United Statesd) China
7-14The Source Of FDISince World War II, the U.S. has been the largest sourcecountry for FDIThe United Kingdom, the Netherlands, France, Germany,and Japan are other important source countries
7-16The Form Of FDI: AcquisitionsVersus Greenfield InvestmentsMost cross-border investment is in the form of mergersand acquisitions rather than greenfield investmentsFirms prefer to acquire existing assets because:mergers and acquisitions are quicker to execute thangreenfield investmentsit is easier and perhaps less risky for a firm to acquiredesired assets than build them from the ground upfirms believe that they can increase the efficiency of anacquired unit by transferring capital, technology, ormanagement skills
7-17The Shift To ServicesFDI is shifting away from extractive industries andmanufacturing, and towards servicesThe shift to services is being driven by: the general move in many developed countries towardservicesthe fact that many services need to be produced wherethey are consumeda liberalization of policies governing FDI in servicesthe rise of Internet-based global telecommunicationsnetworks
7-18Theories Of Foreign Direct InvestmentWhy do firms invest rather than use exporting or licensingto enter foreign markets?Why do firms from the same industry undertake FDI atthe same time?How can the pattern of foreign direct investment flows beexplained?
7-19Why Foreign Direct Investment?Why do firms choose FDI instead of:exporting - producing goods at home and then shippingthem to the receiving country for saleorlicensing - granting a foreign entity the right to produceand sell the firm’s product in return for a royalty fee onevery unit that the foreign entity sells
7-20Why Foreign Direct Investment?An export strategy can be constrained by transportationcosts and trade barriersForeign direct investment may be undertaken as aresponse to actual or threatened trade barriers such asimport tariffs or quotas
7-21Why Foreign Direct Investment?Internalization theory (also known as market imperfectionstheory) suggests that licensing has three major drawbacks:licensing may result in a firm’s giving away valuabletechnological know-how to a potential foreign competitorlicensing does not give a firm the tight control overmanufacturing, marketing, and strategy in a foreign countrythat may be required to maximize its profitabilitya problem arises with licensing when the firm’scompetitive advantage is based not so much on itsproducts as on the management, marketing, andmanufacturing capabilities that produce those products
7-22The Pattern Of ForeignDirect InvestmentFirms in the same industry often undertake foreign directinvestment around the same time and tend to direct theirinvestment activities towards certain locationsKnickerbocker looked at the relationship between FDIand rivalry in oligopolistic industries (industries composedof a limited number of large firms) and suggested that FDIflows are a reflection of strategic rivalry between firms inthe global marketplaceThe theory can be extended to embrace the concept ofmultipoint competition (when two or more enterprisesencounter each other in different regional markets, nationalmarkets, or industries)
7-23The Pattern Of ForeignDirect InvestmentVernon argued that firms undertake FDI at particularstages in the life cycle of a product they have pioneeredFirms invest in other advanced countries when localdemand in those countries grows large enough to supportlocal production, and then shift production to low-costdeveloping countries when product standardization andmarket saturation give rise to price competition and costpressuresVernon fails to explain why it is profitable for firms toundertake FDI rather than continuing to export from homebase, or licensing a foreign firm
7-24The Pattern Of ForeignDirect InvestmentAccording to the eclectic paradigm, in addition to thevarious factors discussed earlier, it is important to consider:location-specific advantages - that arise from usingresource endowments or assets that are tied to a particularlocation and that a firm finds valuable to combine with itsown unique assetsandexternalities - knowledge spillovers that occur whencompanies in the same industry locate in the same area
7-25Classroom Performance SystemAdvantages that arise from using resource endowments orassets that are tied to a particular location and that a firmfinds valuable to combine with its own unique assets area) First mover advantagesb) Location advantagesc) Externalitiesd) Proprietary advantages
7-26Political Ideology AndForeign Direct InvestmentIdeology toward FDI ranges from a radical stance that ishostile to all FDI to the non-interventionist principle of freemarket economiesBetween these two extremes is an approach that mightbe called pragmatic nationalism
7-27The Radical ViewThe radical view traces its roots to Marxist political andeconomic theoryIt argues that the MNE is an instrument of imperialistdomination and a tool for exploiting host countries to theexclusive benefit of their capitalist-imperialist homecountries
7-28The Free Market ViewAccording to the free market view, internationalproduction should be distributed among countriesaccording to the theory of comparative advantageThe free market view has been embraced by a number ofadvanced and developing nations, including the UnitedStates, Britain, Chile, and Hong Kong
7-29Pragmatic NationalismPragmatic nationalism suggests that FDI has bothbenefits, such as inflows of capital, technology, skills andjobs, and costs, such as repatriation of profits to the homecountry and a negative balance of payments effectAccording to this view, FDI should be allowed only if thebenefits outweigh the costs
7-30Shifting IdeologyRecently, there has been a strong shift toward the freemarket stance creating:a surge in FDI worldwidean increase in the volume of FDI in countries with newlyliberalized regimes
7-31Benefits And Costs Of FDIGovernment policy is often shaped by a consideration ofthe costs and benefits of FDI
7-32Host-Country BenefitsThere are four main benefits of inward FDI for a hostcountry:1. resource transfer effects - FDI can make a positivecontribution to a host economy by supplying capital,technology, and management resources that wouldotherwise not be available2. employment effects - FDI can bring jobs to a hostcountry that would otherwise not be created there
7-33Host-Country Benefits3. balance of payments effects - a country’s balance-of-payments account is a record of a country’s payments toand receipts from other countries.The current account is a record of a country’s export andimport of goods and servicesGovernments typically prefer to see a current accountsurplus than a deficitFDI can help a country to achieve a current accountsurplus if the FDI is a substitute for imports of goods andservices, and if the MNE uses a foreign subsidiary to exportgoods and services to other countries
7-34Host-Country Benefits4. effects on competition and economic growth - FDI in theform of greenfield investment increases the level ofcompetition in a market, driving down prices and improvingthe welfare of consumersIncreased competition can lead to increased productivitygrowth, product and process innovation, and greatereconomic growth
7-35Classroom Performance SystemBenefits of FDI include all of the following excepta) The resource transfer effectb) The employment effectc) The balance of payments effectd) National sovereignty and autonomy
7-36Host-Country CostsInward FDI has three main costs:1. the possible adverse effects of FDI on competition withinthe host nationsubsidiaries of foreign MNEs may have greater economicpower than indigenous competitors because they may bepart of a larger international organization
7-37Host-Country Costs2. adverse effects on the balance of paymentswith the initial capital inflows that come with FDI must bethe subsequent outflow of capital as the foreign subsidiaryrepatriates earnings to its parent countrywhen a foreign subsidiary imports a substantial numberof its inputs from abroad, there is a debit on the currentaccount of the host country’s balance of payments
7-38Host-Country Costs3. the perceived loss of national sovereignty and autonomykey decisions that can affect the host country’s economywill be made by a foreign parent that has no realcommitment to the host country, and over which the hostcountry’s government has no real control
7-39Home-Country BenefitsThe benefits of FDI for the home country include:the effect on the capital account of the home country’sbalance of payments from the inward flow of foreignearningsthe employment effects that arise from outward FDIthe gains from learning valuable skills from foreignmarkets that can subsequently be transferred back to thehome country
7-40Home-Country CostsThe home country’s balance of payments can suffer:from the initial capital outflow required to finance the FDIif the purpose of the FDI is to serve the home marketfrom a low cost labor locationif the FDI is a substitute for direct exportsEmployment may also be negatively affected if the FDI isa substitute for domestic production
7-41Classroom Performance SystemWhich of the following is not a cost of outward FDI for hostcountries?a) the initial capital outflow required to finance the FDIb) when FDI is a substitute for direct exportsc) gains from learning valuable skills from foreign marketsd) the effect on employment is FDI is a substitute fordomestic production
7-42International Trade TheoryAnd FDIInternational trade theory suggests that home countryconcerns about the negative economic effects of offshoreproduction (FDI undertaken to serve the home market) maynot be valid
7-43Government Policy InstrumentsAnd FDIHome countries and host countries use various policiesto regulate FDI
7-44Home-Country PoliciesGovernments can encourage and restrict FDI:To encourage outward FDI, many nations now havegovernment-backed insurance programs to cover majortypes of foreign investment riskTo restrict outward FDI, most countries, including theUnited States, limit capital outflows, manipulate tax rules,or outright prohibit FDI
7-45Host-Country PoliciesGovernments can encourage or restrict inward FDITo encourage inward FDI, governments offer incentivesto foreign firms to invest in their countriesIncentives are motivated by a desire to gain from theresource-transfer and employment effects of FDI, and tocapture FDI away from other potential host countriesTo restrict inward FDI, governments use ownershiprestraints and performance requirements
7-46International Institutions AndThe Liberalization Of FDIUntil the 1990s, there was no consistent involvement bymultinational institutions in the governing of FDIToday, the World Trade Organization is changing this bytrying to establish a universal set of rules designed topromote the liberalization of FDI
7-47Implications For ManagersWhat are the implications of foreign direct investment formanagers?Managers need to consider what trade theory implies,and the link between government policy and FDI
7-48The Theory Of FDIThe direction of FDI can be explained through thelocation-specific advantages argument associated withJohn DunningHowever, it does not explain why FDI is preferable toexporting or licensing
7-49Government PolicyA host government’s attitude toward FDI is an importantvariable in decisions about where to locate foreignproduction facilities and where to make a foreign directinvestment