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Foreign Direct Investment
Chapter SixteenEitman, Stonehill, & Moffett
April 19, 2023 1Chapter 16 - Foreign Direct Investment
Absolute advantage (Smith)
Absoluteland 0.2 productive units to produce 1 X 0.3 productive units to produce 1 Y
Relativeland 0.4 productive units to produce 1 X 0.5 productive units to produce 1 Y
Absoluteland has absolute advantage in the production of both X and Y
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Relative Advantage (Ricardo) Absoluteland
The X price of Y is 0.67 The Y price of X is 1.5
Relativeland The X price of Y is 0.8 The Y price of X is 1.25
Relative advantage Absoluteland in X Relativeland in Y
April 19, 2023 Chapter 16 - Foreign Direct Investment
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The world price of X and Y
Perfect world Absoluteland specializes in Y
World X price of Y is between 0.67 and 0.8 Relativeland specializes in X
World Y price of X is between 1.25 and 1.5
Actual price Evolution of trade will determine a
common world price
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Reasons for investment
markets raw materials production cost reduction technology transfers reduction of political risk
April 19, 2023 5Chapter 16 - Foreign Direct Investment
Government interference
Full employment policies Tax breaks for automobile manufacturers
Economic development Bombadier
Essential industries protected Agriculture
Defence related industries Boeing, McDonald/Douglas in the U.S.
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Factors of production mobile
Capital Very efficient world-wide capital markets Flows of capital large Multinationals easily transfer production
Technology Intellectual property is very hard to protect
Labor Illegal immigrants Immigration policy
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Factors of production substituted
Capital for labor (capital investment) Labor for capital (outsourcing) Technology transfers
Through subsidiaries Through joint ventures
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Economies of scale & scope
scale economies production finance research & development transportation purchasing marketing
scope economies finance marketing
April 19, 2023 9Chapter 16 - Foreign Direct Investment
Product & factor markets
new product markets barriers to entry reduction of barriers
factor markets labour money & capital technology goods resource
April 19, 2023 10Chapter 16 - Foreign Direct Investment
Defensive investments
product cycle - cigarette industry declining N. America, steady-state market in
Europe, increasing Eastern Europe, Asia
follow the leader - China conventional wisdom, huge market horizontal or vertical integration
zero-sum game in home markets growth leads to destructive competition
knowledge transfers
April 19, 2023 11Chapter 16 - Foreign Direct Investment
Modes of investment
Production at home and exporting joint venture merger licensing agreement management contract
April 19, 2023 12Chapter 16 - Foreign Direct Investment
Production at home, exporting
Advantages Control Less risk
Political risk
Disadvantages High cost of labor Transaction and operating exposure
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Joint Venture
Advantages partner has country specific knowledge
markets, politics, regulation politicians prefer local ownership Less transaction or operating exposure
Disadvantages lack of control
financing, transfer pricing, strategy valuation is difficult Potential translation exposure
April 19, 2023 14Chapter 16 - Foreign Direct Investment
Mergers & Acquisitions
Advantages economies of scale & scope reduces operating exposure obtain technology Obtain markets Transaction, operating exposure lower
Disadvantages divergent corporate cultures political opposition valuation is difficult Potential translation exposure
April 19, 2023 15Chapter 16 - Foreign Direct Investment
Strategic alliances
Advantages exchanging stock marketing agreements cost sharing agreements
Disadvantages Little control
April 19, 2023 16Chapter 16 - Foreign Direct Investment
Licensing
Advantages No investment costs Partner with knowledge of local markets
disadvantages cash flow & transfer of knowledge may create competitor
April 19, 2023 Chapter 16 - Foreign Direct Investment
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Political risk
change in rules which lead to reallocation of resources tax rules ownership rules/capital controls
restrictions of foreign ownership exchange controls
change in political structure which portends reallocation of resources
April 19, 2023 18Chapter 16 - Foreign Direct Investment
Macro risks
expropriation government seizure of property valuation
book?? Market?? exchange rates??
time value of money civil strife
investment in Yugoslavia, Russia?? antagonistic governments
for US Iran , Cuba ??
April 19, 2023 19Chapter 16 - Foreign Direct Investment
Micro risks - Government Policy Goals employment policies resource reallocation
taxes transfers
trade policies protectionism balance of payments exchange rate policy
economic development
April 19, 2023 20Chapter 16 - Foreign Direct Investment
Barriers
limitations to trade quotas, embargoes, licensing, domestic content
administrative restrictions fees, tariffs, deposit requirements, tax
adjustments
non-economic discrimination quality standards, environmental, health
direct government interference procurement, export subsidies, domestic
subsidies
April 19, 2023 21Chapter 16 - Foreign Direct Investment
Non-economic goal conflicts
economic emperialism African economies
national security concerns U.S. concern
corruption & nepotism South, Central America, Africa, Asia
xenophobia Asian economies
April 19, 2023 22Chapter 16 - Foreign Direct Investment
Assessing Political risk
political stability probability of change direction change would take
firm specific negotiating terms operating strategies to mitigate risk
April 19, 2023 23Chapter 16 - Foreign Direct Investment