Chapter 7 - 1International Business 4e© Prentice Hall, 2008

Chapter 7 Foreign Direct

Investment

© Prentice Hall, 2008 International Business 4e Chapter 7 - 2

Chapter PreviewChapter Preview

• Characterize global FDI flows and patterns• Discuss each theory that tries to explain FDI• Identify important management issues in the

FDI decision• Explain why home and host nations intervene

in FDI flows• List the methods that nations use to promote

and restrict FDI

© Prentice Hall, 2008 International Business 4e Chapter 7 - 3

Foreign Direct InvestmentForeign Direct Investment

Purchase of physical assets or significant amount of ownership of a company in another country to gain some measure of management control

By contrast, portfolio investment does not involve obtaining a degree of control in a company

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Growth of World FDI vs. GDPGrowth of World FDI vs. GDP

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Reasons for FDI GrowthReasons for FDI Growth

IncreasingIncreasingglobalizationglobalization

International mergersInternational mergersand acquisitionsand acquisitions

EntrepreneurshipEntrepreneurshipand small firmsand small firms

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Value of Cross-Border M&AsValue of Cross-Border M&As

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Worldwide FDI FlowsWorldwide FDI Flows

World FDI inflows Developed (58%), developing (36%)

European Union: 33% of world FDI

Developing nations China: 9% of world FDI

All of Africa: 3% of world FDI

70,000 multinationals

with690,000 affiliates

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International Product Life International Product Life CycleCycle

A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle

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Market Imperfections Market Imperfections (Internalization)(Internalization)

Trade barriers(e.g., tariffs)

Specialized knowledge(e.g., managerial ability)

Company undertakes FDI tointernalize a transaction thatis being made inefficient bya market imperfection

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Eclectic TheoryEclectic Theory

A firm undertakes FDI when location, ownership, and internalization advantages combine to make a location appealing

Locationadvantage

(optimal location)

Ownershipadvantage

(special asset)

Internalizationadvantage(efficiency)

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Market PowerMarket Power

A firm undertakes FDI to establish a dominant presence in an industry

Vertical integrationExtends company’s activitiesinto stages of production that provide its inputs (backward integration) or absorb its out-puts (forward integration)

Market power= Greater profits

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Management Issues and FDIManagement Issues and FDI

ControlControl• Partnership requirements• Benefits of cooperation

Purchase-or-buildPurchase-or-builddecisiondecision

Production costsProduction costs• Rationalized production• Cost of R&D

CustomerCustomerknowledgeknowledge

FollowingFollowingrivalsrivals

FollowingFollowingclientsclients

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Balance of PaymentsBalance of Payments

Capital accountCurrent account

National accounting system that records all payments to entities in other countries and all receipts coming into the nation

Records transactions involving the import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country

Records transactions involving the purchase or sale of assets (including assets such as property and shares of common stock in a company)

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Why Host Intervenes in FDIWhy Host Intervenes in FDI

Balance of Payments+

FDI may generate exports

Initial FDI boosts economy

Obtain resourcesand benefits

+

Access technology

Access management skills

Create employment

FDI may decrease import demand

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Why Home Intervenes in FDIWhy Home Intervenes in FDI

– Removes resources from the nation– Can eliminate an export market– Might eliminate domestic jobs

+ May improve national competitiveness+ Can offshore ‘sunset’ industries

FDI

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Host Promotion MethodsHost Promotion Methods

Financial Financial incentivesincentives

Low or waived taxesLow-interest loans

Infrastructure Infrastructure improvementimprovement

ssImproved seaports, roads,

telecommunications networks

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Host Restriction MethodsHost Restriction Methods

Ownership Ownership restrictionsrestrictionsProhibit investment in certain industries

or businesses

Performance Performance demandsdemands

Local content reqmnt.Technology transfers

Export targets

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Home Promotion MethodsHome Promotion Methods

Insurance on assets abroad

Loans and loan guarantees

Tax breaks on profits earned abroad

Special tax treaties

Persuade other nations to accept FDI

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Home Restriction MethodsHome Restriction Methods

Higher tax rates onforeign income

Sanctions on specific nations

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Chapter ReviewChapter Review

• Characterize global FDI flows and patterns• Discuss each theory that tries to explain FDI• Identify important management issues in the

FDI decision• Explain why home and host nations intervene

in FDI flows• List the methods that nations use to promote

and restrict FDI