Foreign Direct Investment (FDI)
Occurs when a firm invests directly in new facilities to produce and/or market in a foreign country (10 percent or more).
- The firm becomes a multinational enterprise.
Flow of FDI
The amount of FDI undertaken over a given time period.
Outflows―flows of FDI out of a country.
Inflows―flows of FDI into a country.
Stock of FDI
The total accumulated value of foreign-owned assets at a given time.
Trends in FDI
Increase in both flow and stock of FDI over past 25 years.
- Growing more rapidly than world trade and world output.
- Way to circumvent trade barriers.
- Political and economic changes.
- Shift towards democratic political institutions and free market economies.
- Globalization
The direction of FDI
Historically, mostly directed at DEVELOPED nations.
- U.S. is a target for FDI inflows.
- Large and wealthy domestic market
- Dynamic and stable economy
- “Favorable political environment” and openness to FDI.
- European inflows mainly from the U.S. and other European nations.
- China has also been a recipient of FDI recently.
Source of FDI
- U.S. is the largest source since WWII.
- 6 countries (U.S., UK, France, Germany, Japan, and the Netherlands) account for 60 percent of all FDI outflows.
_ China became a major foreign investor around 2005, especially in less developed nations.
Greenfield Investment
A type of FDI in which a parent company creates a subsidiary in a different country, building its operations from the ground up.
Aquisitions and Mergers
- Quicker to execute
- Can acquire valuable strategic assets
- Can increase the efficiency of the acquired unit by transferring capital, technology, or management skills.
3 COmplementary Perspectives:
_ Seeks to explain why a firm will favor direct investment as a means of entering a foreign market when two other alternatives, exporting and licensing, are open to it.
_ Attempts to explain the observed pattern of foreign direct investment flows.
_ The eclectic paradigm, attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment.
Limitations of Exporting
- Transportation costs and trade barriers.
- By limiting imports through quotas and tariffs, governments increase the attractiveness of FDI and licensing.
Limitations of Licensing
- Licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitor.
- Licensing does not give a firm the tight control over production, marketing, and strategy in a foreign country that may be required to maximize its profitability.
- The firm’s competitive advantage is based on the management, marketing, and manufacturing capabilities, which is not amenable to licensing.
Advantages of Foreign Direct Investment
- When transportation costs or trade barriers make exporting unattractive.
- When a firm 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.
Oligopoly
A state of limited competition, in which a market is shared by a small number of producers or sellers.
Knickerbocker
Relationship between FDI and rivalry in oligopolistic industries.
The Radical View
- Roots in Marxist political and economic theory.
- The multinational enterprise (MNE) is an instrument of imperialist domination
- Influential view from 1945-1980s
- No longer widely accepted
Free Markeyt View
- Roots in classical economic theory and trade theories of Adam Smith and David Ricardo.
- International production should be distributed among countries according to the theory of comparative advantage.
- FDI is a benefit to both the source country and the host country.
Pragmatic Nationalism
- FDI has both benefits and costs
- Pursue policies designed to maximize the national benefits and minimize the national costs
- Aggressively court FDI believed to be in the national interest
Shifting Ideology
- Decline in radical ideology
- Increase in free market ideology, more liberal foreign investment regime.
(China, Vietnam, India) - Some nations more hostile to FDI
(Venezuela and Bolivia)
FDI Host Country Benefits
- Resource-transfer effects
- Capital, technology, management resources
- Employment effects
- Brings jobs to a host country that would otherwise not be created there
- May be offset by loss of jobs in home country.
- Balance-of-Payments Effects
- Balance of payments accounts track payments and receipts
- Current account tracks exports and imports
- FDI helps with a current account surplus.
Current Account Deficit or Trade Deficit
Arises when a country is importing more goods and services than it is exporting.
Host Country FDI Cons
- Adverse effects on competition
- Subsidiaries of foreign MNEs may have greater economic power than indigenous competitors
- Adverse effects on the balance of payments
- Subsequent capital outflow
Imports of inputs from abroad - Possible effects on national sovereignty and autonomy.
- A loss of economic independence.
Home Country FDI Benefits
- The home country’s balance of payments benefits from the inward flow of foreign earnings
- Employment effects
- Reverse resource-transfer effect
- MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country.
Home COuntry Cons
Balance-of-payments effects of outward FDI
Initial capital outflow
The current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location.
The current account of the balance of payments suffers if the FDI is a substitute for direct exports.
Employment effects
When FDI is a substitute for domestic production
Offshore Production
The manufacturing of a product in another country for import to the market home.
- May stimulate economic growth in home country
- May result in lower prices
- Makes a company more competitive.
