This document discusses foreign direct investment and provides key details: - Foreign direct investment is when a company gains controlling ownership of a business in another country, as opposed to indirect/non-controlling investments. - FDI has increased globally over the past few decades but saw declines in the early 2000s before rebounding. Developing countries are attracting more FDI flows recently. - Both developed and developing country governments generally support FDI but some argue it could harm local industries in certain cases so policies aim to balance costs and benefits.

1. Foreign Direct Investment
Chapter 7

2. 7 - 2
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Extra credit opportunity
• Presentations on
- a country or
- a region (even a town/city in U.S.)
- some other subject in global business
• An especially good chance to discuss your home or
your ancestors’ home

3. 7 - 3
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Length –
- 6 to 10 minutes (individual)
- Up to 18 minutes (group)

4. 7 - 4
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• A country presentation can describe
- The economic environment
• How do people live?
• What is GNI per capita include both
- unadjusted and
- PPP-adjusted GNI,
- compare to US
• How does GNI per capita level affect life?

5. 7 - 5
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
- The political environment
• How is the country/region governed?

6. 7 - 6
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
- Something of the cultural environment
• You can’t summarize the culture;
just say one or two things that strike
you as important
- The country or region’s role in global business
• What does the country or region produce?
• How important is it to people elsewhere?
• Can you tell what is likely to happen in the
future?

7. 7 - 7
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

8. 7 - 8
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
What is foreign direct investment?
• An indirect investment is one where the investor
does not gain control of the entity he or she invests in
- I can buy stock in Toyota, but Toyota’s management
won’t pay much attention to my opinions
• A direct investment is one where the investing
company creates a new business or gains control
- When BP bought the whole of Amoco (a U.S. oil company),
it took control of the firm

9. 7 - 9
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Taking control of the business your firm will
work with may:
- decrease operating costs
• because it results in better coordination
- increase rate of technology transfer
• because businesses are willing to transfer tech
to units they control

10. 7 - 10
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
You can enter foreign markets
without control by…
• Exporting – selling your goods overseas without setting up a
unit abroad that you control
• Licensing – selling others the permission to use your knowhow
- Franchising – where you provide a complete package to allow
others to set up a business like yours – is a kind of licensing

11. 7 - 11
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

12. 7 - 12
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
How companies make foreign direct
investments
• Acquisition: buying an existing company
- Easy to execute
- Gain brand identification and goodwill
- Best if your company is attempting to acquire knowledge
• Building a new unit from scratch (‘Greenfield’
investment):
- hire or buy local resources
- construct or buy buildings
- build own labor force
• Foreign personnel may be difficult to hire
• You control the results

13. 7 - 13
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Foreign direct investment is correlated with profitability.
- Companies that do more foreign direct investment are,
on average, more profitable
• Why?
- Create supremacy over other companies in countries of
interest (monopoly)
- Sell more efficiently
- Get to know markets, resource sources better
- Foreign currency may have a high buying power
- May be able to borrow capital at a lower interest rate than
companies from other countries
The Investor’s Advantage
8-12

14. 7 - 14
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Economists generally favor free flows
of foreign direct investment
• They believe freedom for FDI allows business know-
how to go where it will be most useful
- Just as free trade allows people to use skills and
resources most efficiently
• We haven’t seen the dramatic problems from FDI that
we’ve seen from the global capital market

15. 7 - 15
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Trends in FDI
• Foreign direct investment increased in the last 20 years
• In spite of decline of trade barriers, FDI grew even more
rapidly than world trade because
- Businesses feared protectionist pressures
- FDI is seen a a way of circumventing trade barriers
- Dramatic political and economic changes in many parts of
the world encouraged investment
- Globalization of the world economy created firms who see
the entire world as their market

16. 7 - 16
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
BUT – The FDI Slump
• Between 2000 and 2004 the value of FDI declined almost
50% from $1.2 trillion to about $620 billion
• The slowdown in FDI flows was most pronounced in
developed nations
• Then FDI increased dramatically 2005-2007
- And slowed radically in 2008-10

17. 7 - 17
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Trends In FDI
Figure 7.1: FDI Outflows 1982-2006 ($ billions)

18. 7 - 18
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Direction of FDI
• Historically, most FDI was directed at the developed
nations
- advanced countries invested in other markets
- The US has been the favorite target for FDI inflows
• While developed nations still account for the largest
share of FDI inflows, FDI into developing nations
has increased
- Most recent inflows into developing nations have been
targeted at the emerging economies of South, East,
and Southeast Asia
- Flows to Africa are growing, especially from China

19. 7 - 19
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Foreign Direct Investment in the
World Economy
• The flow of FDI refers to the amount of FDI
undertaken over a given time period
• The stock of FDI refers to the total accumulated
value of foreign owned assts at a given time

20. 7 - 20
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Direction Of FDI
Figure 7.3: FDI Inflows by Region ($ billion), 1995-2006

21. 7 - 21
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Direction Of FDI
Figure 7.4: Inward FDI as a % of
Gross Fixed Capital Formation 1992-2005

22. 7 - 22
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• ‘Gross fixed capital formation’ is the total amount of
investment in factories, stores, office buildings, and the like

23. 7 - 23
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Source of FDI

24. 7 - 24
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Shift to Services
• A shift to services is being driven by four factors
- In many developed economies, services make up growing
portions of GNI
- Many services cannot be traded internationally
- Many countries have liberalized their regimes governing
FDI in services
- The rise of Internet-based global telecommunications
networks has allowed some service enterprises to relocate
some of their value creation activities to different nations to
take advantage of favorable factor costs

25. 7 - 25
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

26. 7 - 26
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Should a nation always accept
foreign investment?
• 19th Century political economists showed countries gain hugely
from trade, but the case for allowing free foreign direct
investment is not as strong
• Foreign firms bring technology and knowhow to a country
• But they can also take over positions in the local economy
where local firms could
- learn new technology,
- earn profits they would keep at home, and
- create more jobs than a foreign firm

27. 7 - 27
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Free Market View
• Nations specialize in goods and services that they can
produce most efficiently
• Resource transfers benefit and strengthen the host
country. It
- gains investments
- gets new jobs
- substitutes for imports
- gets smart new competition in the domestic economy
• Recent changes in laws and growth of bilateral
agreements attest to strength of free market view

28. 7 - 28
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Pragmatic Nationalism
• FDI has benefits and costs
• Allow FDI if benefits outweigh costs
- Block FDI that ‘harms indigenous industry’
- Court FDI that ‘is in national interest’
• Tax breaks
• Subsidies

29. 7 - 29
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Many of the most successful developing countries – past and
present – followed a pragmatic nationalistic stance
- Japan
- South Korea
- China
• Economists note that Hong Kong, which followed the
free market approach, was even more successful

30. 7 - 30
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The richest countries all practice a
basically free market approach
• They have an association, the Organization for Economic
Cooperation and Development that requires members to
open their markets to foreign direct investment

31. 7 - 31
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

32. 7 - 32
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Business Decision Making Grid
for foreign direct investment

33. 7 - 33
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

34. 7 - 34
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Slides below here were not presented in class and are not
required

35. 7 - 35
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Political Ideology and FDI
Radical
View
Pragmatic
Nationalism
Free
Market

36. 7 - 36
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Radical View
• Marxist view: MNE’s exploit less-developed host
countries
- Extract profits
- Give nothing of value in exchange
- Instrument of domination, not development
- Keep less-developed countries relatively backward
and dependent on capitalist nations for investment,
jobs, and technology

37. 7 - 37
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Radical View
• By the end of the 1980s radical view was in retreat
- Collapse of communism
- Bad economic performance of countries that embraced the
radical view
- Strong economic performance of some countries who
embraced capitalism rather than the radical view

38. 7 - 38
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

39. 7 - 39
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Costs of FDI to the
Home Country
• Can drive out local competitors or prevent their
development
• Profits brought home ‘hurt’ (debit) a host’s capital
account
• Parts imported for assembly hurt trade balance
• Can affect sovereignty and national defense

40. 7 - 40
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

41. 7 - 41
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

42. 7 - 42
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

43. 7 - 43
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
The Benefits of FDI to
Host Countries
• Four main benefits of FDI for a host country
- Resource-transfer effect
- Employment effect
- Balance-of-Payments effect
- Effect on competition and economic growth
• In a free market view
- Many economists argue that the benefits of FDI so outweigh the
costs associated with pragmatic nationalism that it is misguided
- The best policy would be for countries to forgo all intervention in
an MNE’s investment decisions

44. 7 - 44
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

45. 7 - 45
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
“Horizontal” FDI
• Horizontal Direct Investment
- FDI in the same industry abroad as company operates at
home
• 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

46. 7 - 46
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
“Horizontal” FDI – When
• Transportation costs for a product are high
• Market Imperfections (Internalization Theory)
- Impediments to the free flow of products between nations
- Impediments to the sale of know-how
• Follow the lead of a competitor - strategic rivalry
• Product Life Cycle - however, does not explain when
it is profitable to invest abroad
• Location specific advantages (natural resources)

47. 7 - 47
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

48. 7 - 48
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

49. 7 - 49
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.

50. 7 - 50
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
• Info on slides below here is not required

51. 7 - 51
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Vertical FDI
• Vertical FDI takes two forms
- Backward vertical FDI is an investment in an industry
abroad that provides inputs for a firm’s domestic
production processes
- Forward vertical FDI occurs when an industry abroad
sells the outputs of a firm’s domestic production
processes, this is less common than backward vertical
FDI

52. 7 - 52
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Strategic Behavior
• One explanation for firm’s choice of vertical FDI is
that by using vertical backward integration, a firm can
gain control over the source of raw materials
- This would allow the firm to raise entry barriers and shut
new competitors out of an industry
• Another explanation of vertical FDI is that firms use
this strategy to circumvent the barriers established by
firms already doing business in a country

53. 7 - 53
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Market Imperfections
• The market imperfections approach offers two
explanations for vertical FDI
- There are impediments to the sale of know-how through
the market mechanism
- Investments in specialized assets expose the investing firm
to hazards that can be reduced only through vertical FDI

54. 7 - 54
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Gross Capital Fixed Formation

55. 7 - 55
McGraw-Hill/Irwin
International Business, 6/e, 7e
Portions © 2007-2009 The McGraw-Hill Companies, Inc., All
Rights Reserved.
Market Imperfections
• Market imperfections are factors that inhibit markets from
working perfectly
- In the international business literature, the marketing imperfection
approach to FDI is typically referred to as internalization theory
• 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