FOREIGN DIRECT INVESTMENT

PRESENTED BY TITO R.MHAGAMA

MBA-3rd SEMESTER

SMBS-MG. UNIVERSITY.

OUT LINE Definitions.Theories of FDI.Forms of FDI.Strategies of FDICost Benefits of FDIConclusion.Reference.

DEFINING FDIIs a process where by residents of one country(source

country) acquire ownership of assets for the purpose of controlling the production and distribution and other activities.

IMF’s Balance of Payment manual defines FDI as an investment that is made to acquire lasting interest in an enterprise operating in an economy other than that of an investor, the investor’s purpose being to have voice in the management of the enterprise.

The United Nations(1999)World Investment Report(UNICTAD)defines FDI as an investment having involving long term relationship and reflecting a lasting interest and control of resident entity in one economy in an enterprise resident in an economy other than that of the foreign direct investor.

Cont…United States Department of Commerce

regards a foreign business as US foreign affiliate if a US single investor owns at least 10 percent of the voting securities.

The distinguishing feature of FDI in comparison with other forms of international investments is the element of control over the management policy and decision. Razin(1999).

THEORIES OF FDIMac Dougall-Kemp Hypothesis.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 .According to this theory, foreing direct investment is a result of differences in capital abundance between economies. This theory was developed by MacDougal(1958) and was later elaborated by Kemp(1964)

Cont…Industrial Organization Theory.According to this theory, MNC with superior

technology moves to different countries to supply innovated products making in turn ample gains .Krugman (1989) points out that it was technological advantage possessed by European countries which led to massive investment in USA .According to this theory, technological superiority is the main driving force for foreign direct investment rather that capital abundance.

Cont…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. Froot and Stain(1989)holds that, depreciation in real value of currency of a country lowers the wealth of a domestic residents visa avis the wealth of the foreign residents ,thus being cheaper for foreign firms to acquire assets in such countries. Therefore, foreign direct investments will move from countries with strong currencies to those with weak or depreciating currencies.

Cont…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. Since real wage cost varies among countries, firms with low-cost technology move to low wage countries. Abundance of raw materials and cheap labor force are the main factors for FDI.Countries with cheap labor and abundant raw material will tend to attract FDI.

Cont…Product Cycle Theory.FDI takes place only when the product in question

achieve specific stage in its life cycle(Vernon 1966)introduction ,growth, maturity and decline stage.

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.

So in order to compete with rivals, innovators decide to set up production in the host country so as to beat up the cost of transportation and tariffs.

cont…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).

FORMS OF FDIIt takes broadly three forms:1.Green Field Investment2.Merger and Acquisitions(M&A)3.Brown Field Investment.

Cont… 1.Green Field Investment.IT is done through opening branches in host

countries or through making investment in the equity capital of the host country firm.(Financial collaboration)

If the parent hosts the entire equity of the host country firm, the late is called wholly owned subsidiary of the of the parent.

If it is more than half, it is known as subsidiary. otherwise, it is simply an affiliate.

Cont…2.Merger and Acquisition(M&A)They are either purchase of a running company

abroad or an Amalgamation with a running foreign company.

For the case of Merger, the acquiring company maintains its existence and the target company looses its existence.

For the case of Amalgamation, both loose their existence in the favor of a new company.

Merger and Acquisition are either Horizontal or Vertical Conglomerate.

Cont…

Horizontal Conglomerate is when two or more firms engaged in similar activities combine.Vertical is when two firms involved in different stages of production of a single final product combine.eg Oil exploration with a refining . Brown Field.Is a combination of Green field and M&A and then make huge investment for replacing plant and machinery in the target company.

Strategy for FDIFirm-Specific Strategy.It means offering new kind of product or differentiated

product. When product innovation fails to work, a firm may adopt product differentiation strategy. This is done through putting trade mark on the product or branding. Sometimes a firm may adopt different brands for different markets to make them suitable for local markets. Bata for example, operates in 92 countries under the same trade mark, while Uniliver’s low - leather fabric washing product is marketed is market under five different brands in Western Europe.

Cost –Economic Strategy.This strategy is done through lowering cost by moving

the firm to the places where there are cheap factors of production(eg.labour and raw materials).The cheapness of these factors of production reduces the cost of production and maintains an edge over other firms.

Strategies for Entering New Markets. Joint Venture With a Rival Firm.Sometimes when a rival firm in a host country is so

powerful that it is not easy for MNC to compete, the later prefer to join hands with the host country firm for a joint venture agreement and the MNC is able to operate the host country market.

Investment Mode Strategy: Merger versus GI.This strategy depends on the move of investment

favored by the host country. It depends also on the political and economic environment of the host country. If the host government does not favor a particular mode, an investing company can not adopt it even if it is the most suitable.

Cost and Benefits of FDI Benefits to The Host Country.1.Availability of scarce factors of production 2.Improvement in Balance of Payments through

export and import substitution.3.Building of economic and social

infrastructure.4.Fostering of economic linkages.5.Strengthening of the government budget.6. Stimulation of national economy. Subsidiaries

of Trans-National Corporations (TNCs), which bring the vast portion of FDI, are estimated to produce around a third of total global exports (UNCTAD 1999).

Cont...Benefits to The Home Country.1.Availability of raw material.2.Improvement in Balance of Payments.3.Revenue to the government4.Employement generation5.Improved political relations.

Cont…Cost to the Home Country.1.Cultural and political interference.2.Un healthy competition3.Over utilization of local resources(both

natural and human resources)4.Vilation of human rights(child labor eg. the

case of NIKE in Vietnam).5.Threat to indigenous technology.6.Threat to local products.

Cont.. Cost to the Home Country.It is little compared to the host country.1.Investment abroad takes away employment

opportunities.2.It takes away capital.3.Out flow of factors of production.

REFERENCEUNICTAD(2002) Foreign Direct Investment: A Lead

Driver for Sustainable Development, Economic Briefing Series No. 1,Whitehall Court, London.

The Location of Foreign Direct Investment Activities: Country Characteristics and Experience Effects(1980) Journal of International Business Studies,  Palgrave Macmillan Journals.

Vyuptakesh(2009) International Financial Management, Delhi, PHI Learning Private.

How does foreign direct investment affect economic growth?(1998) Journal of International Economics, Volume 45, Issue 1 , 1 June 1998, Pages 115-135.