ch7 Competing in the Global Marketplace

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International BusinessCompeting in the Global Marketplace

8e

By Charles W.L. Hill


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Chapter 7

Foreign DirectInvestment


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What Is FDI?

Foreign direct investment(FDI) occurs when afirm invests directly in new facilities to produceand/or market in a foreign countrythe firm becomes a multinational enterprise (MNE)

FDI can be in the form ofgreenfield investments- the establishment of a

wholly new operation in a foreign countryacquisitions or mergers (M&As) with existing firms in

the foreign country

Outflows of FDIare the flows of FDI out of acountry while inflows of FDIinto a country

The stock of FDIrefers to the total accumulatedvalue of foreign-owned assets at a given time


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What Are the Patterns of FDI?

Both the flow and stock of FDI have increased overthe last 30 yearsMost FDI is targeted towards developed nationsSouth, East, and Southeast Asia - China and Latin

America are emerging

FDI has grown more rapidly than world trade andworld outputdemocratic political institutions and free market

economies have encouraged FDI

globalization is forcing firms to maintain a presencearound the world

FDI is an important source of capital investment anda determinant of the future economic growth


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FDI Outflows 1982-2008 ($ billions)


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FDI Inflows by Region 1995-2008 ($ billion)


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Inward FDI as a % of Gross Fixed CapitalFormation 1992-2007


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What Is the Source of FDI?

Since World War II, the U.S. has been thelargest source country for FDI

the United Kingdom, the Netherlands, France,

Germany, and Japan are other important sourcecountries

together, these countries account for 56% of allFDI outflows from 1998-2006, and 61% of thetotal global stock of FDI in 2007


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Cumulative FDI Outflows 1998-2007 ($ billions)


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Why Do Firms Choose AcquisitionOver Greenfield Investments?

Most cross-border investment is in the form ofmergers and acquisitions (M&As) rather thangreenfield investments

Firms prefer to acquire existing assets because

M&As are quicker to execute than greenfieldinvestments

it is easier and perhaps less risky for a firm to acquiredesired assets than build them from the ground up

firms believe that they can increase the efficiency ofan acquired unit by transferring capital, technology,or management skills


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Why Does FDI in Services Occur?

FDI is shifting away from extractive industries andmanufacturing, and towards services

The shift to services is being driven by

the general move in many developed countriestoward services

many services need to be produced where they areconsumed

a liberalization of policies governing FDI in services

the rise of Internet-based globaltelecommunications networks


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Why Choose FDI?

1. Exporting- producing goods at home andthen shipping them to the receiving countryfor sale. However,The viability of an exporting strategy can be

limited by transportation costs and tradebarriers By limiting imports through quotas, government

increase the attractiveness of FDI and licensing

FDI may be a response to actual or threatenedtrade barriers such as import tariffs or quotas


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Why Choose FDI?1. Licensing

- granting a foreign entity the rightto produce and sell the firms product inreturn for a royalty fee

Internalization theory(market imperfectionstheory) seeks to explain why firms FDI over

licensing by suggesting three major drawbacks oflicensing firm could give away valuable technological know-

how to a potential foreign competitor

does not give a firm the control over manufacturing,marketing, and strategy in the foreign country the firms competitive advantage may be based on

its management, marketing, and manufacturingcapabilities


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What Is the Pattern of FDI?

Why do firms in the same industry undertake FDIat about the same time and the same locations?

Knickerbockersstrategic behavior theory - FDI

flows are a reflection of strategic rivalry betweenfirms in the global marketplace

Multipoint competition- when two or moreenterprises encounter each other in different

regional markets, national markets, or industriesRaymond Vernon - firms undertake FDI at

particular stages in the life cycle of a product


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What Is the Pattern of FDI?

Why is it profitable for firms to undertake FDI?

According to Dunnings eclectic (OLI) paradigm,

FDI is undertaken when firms possess ownership,internalization, and location advantages; OLI

paradigm particularly considerlocation-specific advantages- that arise from using

resource endowments or assets that are tied to aparticular location and that a firm finds valuable to

combine with its own unique assets

externalities- knowledge spillovers that occur whenfirms in the same industry locate in the same area


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What is Political Ideology toward FDI?

The radical view- the MNE is an instrument ofimperialist domination and a tool for exploiting hostcountries

The free market view- international productionshould be distributed according to the theory of

comparative advantagePragmatic nationalism- FDI has both benefits

(inflows of capital, technology, skills and jobs) andcosts (repatriation of profits and a negative balance

of payments effect); FDI should be allowed if thebenefits outweigh the costsRecently, there has been a strong shift toward the

free market stance creating a surge in FDI worldwide


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How Does FDI BenefitThe Host Country?

Four main benefits of inward FDI for a host country1. Resource transfer effects- FDI brings capital,

technology, and management resources2. Employment effects- FDI can bring jobs

3. Balance of payments effects- FDI can help acountry to achieve a current account surplus

4. Effects on competition and economic growth-greenfield investments increase the level of

competition, driving down prices and improvingthe welfare of consumerscan lead to increased productivity growth, product

and process innovation, and greater economic growth


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What Are the Costs ofFDI to the Host Country?

Inward FDI has three main costs:1. Adverse effects of FDI on competitionsubsidiaries of foreign MNEs may have greater

economic power than indigenous competitors

2. Adverse effects on the balance of paymentswhen a foreign subsidiary imports its inputs from

abroad, there is a debit on the current account ofthe host countrys balance of payments

3. Perceived loss of national sovereignty/autonomydecisions that affect the host country will be made

by a foreign parent, over which the host countrysgovernment has no real control


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How Does FDI BenefitThe Home Country?

The benefits of FDI for the home country:

1. The effect on the capital account of the homecountrys balance of payments from the inward

flow of foreign earnings

2. The employment effects that arise from outwardFDI

3. The gains from learning valuable skills fromforeign markets that can subsequently betransferred back to the home country


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What Are the Costs ofFDI to the Home Country?

1. The home countrys balance of payments cansuffer

from the initial capital outflow

if the purpose of the FDI is to serve the home

market from a low cost labor locationif the FDI is a substitute for direct exports

2. Employment may also be negatively affected ifthe FDI is a substitute for domestic production

But, home country concerns about the negativeeconomic effects of offshore production(FDIundertaken to serve the home market) may not bevalid


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How Does GovernmentInfluence FDI?

Governments can encourage outward FDI

government-backed insurance programs to covermajor types of foreign investment risk

Governments can restrict outward FDI

limit capital outflows, manipulate tax rules, oroutright prohibit FDI

Governments can encourage inward FDI by offeringincentives to foreign firms to invest, thus gaining fromthe resource-transfer and employment effects of FDI

Governments can restrict inward FDI using ownershiprestraints and performance requirements


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How Do InternationalInstitutions Influence FDI?

Until the 1990s, there was no consistentinvolvement by multinational institutionsin the governing of FDI

Today, the WTO has become involved inregulations governing FDI, particularly inservices

trying to establish a universal set of rulesdesigned to promote the liberalization of FDI


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What Does FDI Mean for Managers?

Managers need to consider what trade theory impliesabout FDI, and the link between government policyand FDI

The direction of FDI can be explained through the

location-specific advantages argument associated withDunnings OLI paradigm

However, it does not explain why FDI is preferable toexporting or licensing, which is explained byinternalization theory

A host governments attitude toward FDI is animportant variable in decisions about where to locateforeign production facilities and where to make FDI


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What Does FDI Mean for Managers?

A Decision Framework


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Review Questions

1. The establishment of a wholly new operationin a foreign country is called __________.

2. The amount of FDI undertaken over a giventime period is known as ____________.

3. Most FDI is direct toward

a) developed countries b) emerging economies

c) the United States d) China


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Review Questions

4. Advantages that arise from using resourceendowments or assets that are tied to a particularlocation and that a firm finds valuable to combinewith its own unique assets are

a) First mover advantages b) Location advantages

c) Externalities d) Proprietary advantages

5. Which theory is based on the idea thatFDI flows are a reflection of strategic rivalrybetween firms in the global marketplace?


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Review Questions

6. Benefits of inward FDI for a host countryinclude all of the following except __________.

a) The resource transfer effectb) The employment effect

c) The balance of payments effect

d) National sovereignty and autonomy


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Review Question

7. Which of the following is not a cost of outwardFDI for host countries?

a) the initial capital outflow required to finance

the FDIb) when FDI is a substitute for direct exports

c) gains from learning valuable skills fromforeign markets

d) the effect on employment is FDI is a substitutefor domestic production

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ch7 Competing in the Global Marketplace