These slides are about Foreign Direct Investment.

1. LECTURE 6: FOREIGN DIRECT INVESTMENT

2. Introduction
Foreign direct investment (FDI) occurs when a firm invests directly in new
facilities to produce and/or market in a foreign country. The firm becomes a
multinational enterprise.
Foreign direct investments are distinguished from portfolio investments in which
an investor merely purchases equities of foreign-based companies. The key
feature of foreign direct investment is that it is an investment made that
establishes either effective control of, or at least substantial influence over, the
decision making of a foreign business.

3. What are the patterns of FDI?
It takes broadly three forms:
a. Green Field Investment.
b. Merger and Acquisitions(M&A).
c. Brown Field Investment
The flow of FDI - the amount of FDI undertaken over a given time period
✔ outflows of FDI are the flows of FDI out of a country
✔ inflows of FDI are the flows of FDI into a country
▪ The stock of FDI - the total accumulated value of foreign-owned assets at a
given time .
▪ Both the flow and stock of FDI have increased over the last 30 years due to
lack of protectionism, economical and political changes, new treaties and
globalization.

4. Why do Firms Choose Acquisition over Greenfield
Investment
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.
Most cross-border investment is in the form of mergers and acquisitions rather
than greenfield investments.

5. Theories of FDI
▪ Mac Dougall-Kemp Hypothesis
According to this theory, FDI moves from capital abundant economy to
capital scarce economy till the marginal production is equal in both countries.
This leads to improvement in efficiency in utilization of resources in which
leads to ultimate increase in welfare.
▪ Industrial Organization Theory (Paul krugman)
According to this theory, MNC with superior technology moves to different
countries to supply innovated products making in turn ample gains.
▪ Currency Based Approaches
A firm moves from strong currency country to weak currency country. Aliber
(1971) postulates that firms from strong currency countries move out to
weak currency countries.

6. Theories of FDI
▪ Political –Economic Theories
They concentrate on the political risks. Political stability in the host
country leads to FDI(Fatehi-Sedah and Safizeha 1989).Similarly,
political instability in the home country encourages FDI in other
countries(Tallman 1988).
▪ Location –Specific Theory
Hood and Young(1979) stress on the location factor. According to
them, FDI moves to a countries with abundant raw materials and
cheap labor force.
▪ Product Cycle Theory
At maturity stage, the demand for new product in developed countries
grow substantially and rival firms begin to emerge producing similar
products at lower price.

7. Attitudes Towards FDI
▪ The radical view - 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 .
▪ The free market view - international production should be distributed among
countries according to the theory of comparative advantage.
▪ Pragmatic nationalism - 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).

8. What does FDI Mean for the Host Country?
▪ 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
▪ Costs of inward FDI for a host country
1. Adverse effects on competition within the host nation
2. Adverse effects on the balance of payments
3. Perceived loss of national sovereignty and autonomy

9. What does FDI mean for the Home country
▪ Benefits of FDI for the home country include
1. The positive effect on the capital account 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 for the home country include
1. The negative effect on the balance of payments .
2. Employment may also be negatively affected if the FDI is a substitute
for domestic production

10. How Does Government Influence FDI
▪ Governments can encourage outward FDI
government-backed insurance programs to cover major types of foreign
investment risk
▪ Governments can restrict outward FDI
limit capital outflows, manipulate tax rules, or outright prohibit FDI
▪ Governments can encourage inward FDI
offer incentives to foreign firms to invest in their countries
▪ Governments can restrict inward FDI
use ownership restraints and performance requirements

11. What does FDI mean for Managers?
▪ Managers need to consider what trade theory implies about FDI, and the link
between government policy and FDI.
▪ The direction of FDI can be explained through the location-specific
advantages argument associated with John Dunning
▪ A host government’s attitude toward FDI is an important variable in decisions
about where to locate foreign production facilities and where to make a
foreign direct investment.

12. What is the Future of the World Trade
Organization?
▪ The current agenda of the WTO focuses on
✔ the rise of anti-dumping policies
✔ the high level of protectionism in agriculture
✔ the lack of strong protection for intellectual property rights in many
nations
✔ continued high tariffs on nonagricultural goods and services in
many nations
▪ The WTO launched a new round of talks at Doha, Qatar in 2001 that
were still going on in 2011
▪ The agenda includes
✔ cutting tariffs on industrial goods and services
✔ phasing out subsidies to agricultural producers
✔ reducing barriers to cross-border investment
✔ limiting the use of anti-dumping laws