Global Business Management - PUC's Students need it.

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Foreign Direct Investment
and Regional Integration
DY Chhunsong
Lecture 5
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Fundamentals of Global Business Management
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What Is Foreign Direct Investment (FDI)?
The purchase of physical assets or a significant amount of
ownership (stock) of a company in another country to gain a
measure of management control.
Portfolio Investment: Investment that does not involve obtaining a
degree of control in a company.

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Why Does FDI Exist?
International Product Life Cycle: A company will begin by
exporting its product and later undertake foreign direct investment
as the product moves through its life cycle.
International Product Life Cycle has 3 stages which include New
Product Stage, Maturing Product Stage, and Standardized Product
Stage (link the stage to the concept of the theory).
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Why Does FDI Exist (1)?
Market Imperfections: When an imperfection in the market makes
a transaction less efficient, a firm will undertake FDI to improve the
transaction.
A market that operates at lowest prices as possible and where
goods are readily and easily available is said to be perfect. But it is
rarely seen due to Trade Barriers (tariffs) and Specialized
Knowledge (sharing specialty can create future competitors).

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Why Does FDI Exist (2)?
Eclectic Theory: Firms undertake FDI when features of a particular
location (natural resources, productive workforce..) combine with
ownership benefits to make a location appealing for investment.
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Why Does FDI Exist (3)?
Market Power: A firm tries to establish a dominant market
presence in an industry by undertaking foreign direct investment.
The benefit of market power is greater profit as the firm is far better
able to dictate the cost of its inputs and/or the price of its output.

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Management Issues in the FDI Decision
Control: Companies investing abroad are concerned with controlling
the activities that occur in the local market they invest.
A company may want its products to be marketed and the selling
prices remain the same as it does at home. It also wants to have full
ownership of the local operations.
Hence, many local governments do not allow full ownership for
any foreign company.
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Management Issues in the FDI Decision (1)
Purchase-or-Build Decision: Should the company purchase an
existing business or run a new one abroad (Greenfield investment).
Purchasing an existing business may provide the company some
benefits: plant and equipment, personnel, goodwill, brand
recognition, and methods of financing the purchase.
Building its subsidiary can help the company to avoid obsolete
equipment, poor relations with workers, and an unsuitable location.

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Management Issues in the FDI Decision (2)
Production Costs: Many factors that affect the cost of production
in any market such as labor cost and regulations, knowledge and
skills, cost of land and building, cost of raw materials, power
supply, and the tax rate.
If those factors are too costly, a company would not consider
investing in that local market.
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Management Issues in the FDI Decision (3)
Customer Knowledge: The behavior of local buyers is an
important issue in the decision of whether to undertake FDI.
Without real knowledge about customer’s behavior, a company
may find it hard to tailor its products accordingly.

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Management Issues in the FDI Decision (4)
Following Clients: Where are the clients? By undertaking FDI, can
a company stay closer to its clients?
Following Rivals: Where are the rivals? If a company does not
follow its rivals it may lose that market share. By undertaking FDI,
can a company compete with its rivals?
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Reasons for Intervention by the
Host Country in FDI Flows
Balance-of-Payments: Governments see intervention as the only
way to keep their balance of payments (records all payments to
entities of other nations and receipts) under control.
Obtain Resources and Benefits: Governments intervene in FDI
flows just to acquire resources and benefits such as technology,
management skills, and employment.

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Reasons for Intervention by the
Home Country in FDI Flows
• Investing in other nations sends resources out of the home
country. Thus, less resources are available at home.
• Outgoing of FDI may ultimately damage a nation’s balance of
payments by taking the place of its exports.
• Job resulting from outgoing investments may replace jobs at
home.
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Government Policy Instruments and FDI
FDI Promotion FDI Restriction
Host Countries Tax incentives
Low-interest loans
Infrastructure improvements
Ownership restrictions
Performance demands
Home Countries Insurance
Loans
Tax breaks
Political pressure
Differential tax rates
Sanctions

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What Is Regional Economic Integration?
Process whereby countries in a geographic region cooperate with
one another to reduce or eliminate barriers to the international flow
of products, people, or capital.
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Levels of Regional Integration
Political
Union
Economic Union
Common Union
Customs Union
Free-Trade Area

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Levels of Regional Integration (1)
Free-Trade Area: Economic integration whereby countries seek to
remove all barriers to trade between themselves, but each country
determines its own barriers against nonmembers.
Customs Union: Economic integration whereby countries remove
all barriers to trade between themselves, but erect a common trade
policy against nonmembers.
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Levels of Regional Integration (2)
Common Market: Economic integration whereby countries remove
all barriers to trade and the movement of labor and capital between
themselves, and erect a common policy against nonmembers.
Economic Union: Economic integration whereby countries remove
all barriers to trade and the movement of labor and capital between
themselves, erect a common policy against nonmembers, and
coordinate their economic policies.
Political Union: Economic and political integration whereby count-
ries coordinate aspects of their economic and political systems.

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Benefits of Regional Integration
Trade Creation: Increase in the level of trade between nations that
results from regional economic integration.
Greater Consensus: Regional economic integration has fewer
members than WTO and that it is easier to gain consensus.
Political Cooperation: When nations integrate together, they can
gain political weight comparing to each of them alone (coalition).
Employment Opportunities: Allow people to move from one
nation to another to look for job.
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Drawbacks of Regional Integration
Trade Diversion: Diversion of trade away from nations not
belonging to a trading bloc (others cannot compete).
Shifts in Employment: Lower-labor-wage nations will get more
jobs while higher-labor-wage nations will lose jobs.
Loss of National Sovereignty: Successful levels of integration
require that nations surrender more of their national sovereignty.

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Blocs of Economic Integration
European Union (EU), European Free Trade Agreement (EFTA),
North American Free Trade Agreement (NAFTA), Andean
Community (Andean), Latin American Integration Association
(ALADI), Southern Common Market (MERCOSUR), Caribbean
Community and Common Market (CARICOM), Central American
Common Market (CACM), Free Trade Area of the Americas
(FTAA), and many others.. Check page 235 for more..