1. Foreign Direct Investment

3. Foreign Direct Investment
 Why is FDI increasing in the world economy?
 Why do firms often prefer FDI to other market
entry strategies?
 Why do firms imitate competitors with FDI
strategies?
 Why are certain locations favored for FDI?
 How does political ideology affect government
FDI policy?
 What are key FDI related costs and benefits for
receiving and source countries?

4. Foreign Direct Investment
 Foreign direct investment (FDI): a firm
invests directly in foreign facilities
Afirm that engages in FDI becomes a
multinational enterprise (MNE)
– Multinational = “more than one country”
 Factors which influence FDI are related to
factors that stimulate trade

5. Foreign Direct Investment
 Involves ownership of entity abroad for
– production
– Marketing/service
– R&D
– Access of raw materials or other resource
 Parent has direct managerial control
– Depending on its extent of ownership and
– On other contractual terms of the FDI
 No managerial involvement = portfolio investment

6. FDI Growth in the World
Economy
 FDI Outflow: $35 billion in ‘75 to $1.3 trillion in ‘00 to
$653 billion in ‘03
 FDI Flow (from all countries): from ‘92 to ‘02 up 292%,
compared to trade up 69% and world output up 28%
 FDI Stock: $3.5 trillion by ‘97 to > $7 trillion in ‘02
 In ‘02:
– 64,000 MNEs had:
 850,000 foreign affiliates
 53 million employees
 $17.7 trillion in sales
– $8 trillions global exports
 Conclusion:
FDI flow growing faster than world trade and world output

8. Direction and Source of FDI
 MostFDI flow has been to developed
countries from developed countries
– Much to the US from EU, Japan
 FDI increase to developing countries since
‘85
– Much to the emerging Asian and Latin
America economies
– Africa lagging

10. Forms of FDI
 FDI forms
– Purchase of assets: why? why not?
 Quick entry, local market know-how, local financing may be
possible, eliminate competitor, buying problems
– New investment: why? why not?
 No local entity is available for sale, local financial incentives, no
inherited problems, long lead time to generation of sales
– International joint-venture
 Shared ownership with local and/or other non-local partner
 Shared risk

11. Alternative Modes of Market Entry
 FDI
– FDI - 100% ownership
– FDI < 100% ownership, International Joint
Venture
 Strategic Alliances (non-equity)
 Franchising
 Licensing
 Exports: Direct vs Indirect

12. Why FDI?
 FDI over exporting
– High transportation costs, trade barriers
 FDI over licensing or franchising
– Need to retain strategic control
– Need to protect technological know-how
– Capabilities not suitable for licensing/franchising
 Follow few main competitors
– Immediate strategic responses

14. Pattern of FDI Explanations
 International product life-cycle (Ray Vernon)
– Trade theory similarity
 Eclectic paradigm of FDI (John Dunning)
– Combines ownership specific, location specific,
and internalization specific advantages
– Explains FDI decision over a decision to enter
through licensing or exports

15. Eclectic Paradigm of FDI (Dunning)
 Ownership advantage: creates a monopolistic advantage to be
used in markets abroad
– Unique ownership advantage protected through ownership
– e.g., Brand, technology, economies of scale, management know-how
 Location advantage: the FDI destination market must offer
factors (land, capital, know-how, cost/quality of labor,
economies of scale) that are advantageous for the firm to
locate its investment there (link to trade theory)
 Internalization advantage: transaction costs of an arms-length
relationship --licensing, exports-- higher than managing the
activity within the MNC’s boundaries

16. Government Policy and FDI
 The radical view: inbound FDI harmful; MNEs
– Are imperialist dominators
– Exploit host to the advantage of home country
– Extract profits from host country; give nothing back
– Keep LDCs backward and dependent for investment,
technology and jobs
 The free market view: FDI should be encouraged
– Adam Smith, Ricardo, et al: international production
should be distributed per national comparative
advantage
– An MNE increases the world economy efficiency
 Brings to bear unique ownership advantages
 Adds to local economy’s comparative advantages

17. Host Country Effects of FDI
Benefits
– Resource -transfer
– Employment
– Balance-of-payment (BOP)
 Import substitution
 Source of export increase
Costs
– Adverse effects on the BOP
 Capital inflow followed by capital outflow + profits
 Production input importation
– Threat to national sovereignty and autonomy
 Loss of economic independence

18. Government Policy and FDI
Home country
– Outward FDI encouragement
 Risk reduction policies (financing, insurance, tax incentives)
– Outward FDI restrictions
 National security, BOP
Host country
– Inward FDI encouragement
 Investment incentives
 Job creation incentives
– Inward FDI restrictions
 Ownership extent restrictions (national security; local nationals
can safeguard host country’s interests

19. Decision Framework for FDI
Are transportation costs Import
No No Export
high? Barriers?
Ye
Ye s
s
Is know-how easy to No FDI
license?
Ye
s
Tight control over foreign FDI
Yes
ops required?
No
Yes FDI
Is know-how valuable and
is protection possible?
No License