Slide 1: Foreign Direct Investment SHRI VENKTESHWAR INSTITUTE OF TECHNOLOGY Deepesh Mahajan deepeshmahajanvit@gmail.

com Slide 2: Foreign investment that establishes a lasting interest in or effective management control over an enterprise. Foreign direct investment can include buying shares of an enterprise in another country, reinvesting earnings of a foreign- owned enterprise in the country where it is located, and parent firms extending loans to their foreign affiliates. International Monetary Fund (IMF): International Monetary Fund (IMF) IMFguidelines consider an investment to be a foreign direct investment if it accounts for at least 10 percent of the foreign firm's voting stock of shares. However, many countries set a higher threshold because 10 percent is often not enough to establish effective management control of a company or demonstrate an investor's lasting interest. Economic Growth: Economic Growth Quantitative change or expansion in a country's economy. Economic growth is conventionally measured as the percentage increase in gross domestic product (GDP) or gross national product (GNP) during one year. Economic growth comes in two forms: an economy can either grow "extensively" by using more resources (such as physical , human , or natural capital ) or "intensively" by using the same amount of resources more efficiently (productively). When economic growth is achieved by using more labor, it does not result in per capita income growth ,when economic growth is achieved through more productive use of all resources, including labor, it results in higher per capita income and improvement in people's average standard of living . Intensive economic growth requires economic development . Foreign Direct Investment: Foreign Direct Investment Foreign direct investment (FDI): a firm invests directly in foreign facilities A firm that engages in FDI becomes a multinational enterprise (MNE) Multinational = more than one country Foreign Direct Investment: Foreign Direct Investment Factors which influence FDI are related to factors that stimulate trade Involves ownership of entity abroad for production Marketing/service R&D Access of raw materials or other resource Foreign Direct Investment: Foreign Direct Investment Parent has direct managerial control Depending on its extent of ownership and On other contractual terms of the FDI No managerial involvement = portfolio investment FDI Growth in the World Economy: FDI Growth in the World Economy FDI Outflow : $35 billion in 75 to $1.3 trillion in 00 to $653 billion in 03 FDI Flow (from all countries): from 92 to 02 up 292%, compared to trade up 69% and world output up 28% FDI Stock: $3.5 trillion by 97 to > $7 trillion in 02 In 02: 64,000 MNEs had: 850,000 foreign affiliates 53 million employees $17.7 trillion in sales $8 trillions global exports Conclusion: FDI flow growing faster than world trade and world output Direction and Source of FDI: Direction and Source of FDI Most FDI flow has been to developed countries from developed countries Much to the US from EU, Japan FDI increase to developing countries since 85 Much to the emerging Asian and Latin America economies Africa lagging Forms of FDI: Forms of FDI FDI forms Purchase of assets: why? why not? Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems New investment: why? why not? No local entity is available for sale, local financial incentives, no inherited problems, long lead time to generation of sales International joint-venture Shared ownership with local and/or other non-local partner Shared risk Alternative Modes of Market Entry: Alternative Modes of Market Entry FDI FDI - 100% ownership FDI < 100% ownership, International Joint Venture Strategic Alliances (nonequity) Franchising Licensing Exports: Direct vs Indirect Why FDI?: Why FDI? FDI over exporting High transportation costs, trade barriers FDI over licensing or franchising Need to retain strategic control Need to protect technological know-how Capabilities not suitable for licensing/franchising Follow few main competitors Immediate strategic responses Slide 15: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Slide 16:

Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Pattern of FDI Explanations: Pattern of FDI Explanations International product life-cycle (Ray Vernon) Trade theory similarity Eclectic paradigm of FDI (John Dunning) Combines ownership specific, location specific, and internalization specific advantages Explains FDI decision over a decision to enter through licensing or exports Slide 18: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Eclectic Paradigm of FDI (Dunning): Eclectic Paradigm of FDI (Dunning) Ownership advantage: creates a monopolistic advantage to be used in markets abroad Unique ownership advantage protected through ownership e.g., Brand, technology, economies of scale, management know-how Location advantage: the FDI destination market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) that are advantageous for the firm to locate its investment there (link to trade theory) Internalization advantage: transaction costs of an arms-length relationship --licensing, exports-- higher than managing the activity within the MNCs boundaries Government Policy and FDI: Government Policy and FDI The radical view: inbound FDI harmful; MNEs Are imperialist dominators Exploit host to the advantage of home country Extract profits from host country; give nothing back Keep LDCs backward and dependent for investment, technology and jobs The free market view: FDI should be encouraged Adam Smith, Ricardo, et al: international production should be distributed per national comparative advantage An MNE increases the world economy efficiency Brings to bear unique ownership advantages Adds to local economys comparative advantages Host Country Effects of FDI: Host Country Effects of FDI Benefits Resource -transfer Employment Balance-of-payment (BOP) Import substitution Source of export increase Costs Adverse effects on the BOP Capital inflow followed by capital outflow + profits Production input importation Threat to national sovereignty and autonomy Loss of economic independence Government Policy and FDI: Government Policy and FDI Home country Outward FDI encouragement Risk reduction policies (financing, insurance, tax incentives) Outward FDI restrictions National security, BOP Host country Inward FDI encouragement Investment incentives Job creation incentives Inward FDI restrictions Ownership extent restrictions (national security; local nationals can safeguard host countrys interests Decision Framework for FDI: Decision Framework for FDI Export FDI FDI FDI License Yes Import Barriers? No No Yes No Are transportation costs high? Is know-how easy to license? Tight control over foreign ops required? Is know-how valuable and is protection possible? No Yes Yes No Yes Slide 24: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Slide 25: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Slide 26: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Slide 27:

Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Slide 28: Rapid FDI growth in India from 2005 onwards FDI in India (US$ Bn) 19.7 7.6 5.0 2000-04 2005 2006 (Average) FDI Growth Rate (2004-08) 70% 65% 60% 33.7 55% 50% 45% 40% 23.0 35% 30% 25% 20% 15% 10% 5% 0% 2007 2008 0% 1% Global comparison of FDI (%) India Russia Brazil China Share of Global FDI 2% 3% 4% 5% 6% 7% 8% (2008) Source: World Investment Report, IHS Global Insight, CIA, DIPP, Ministry of Finance, World Economic Forum, Media Reports, Booz & Company Analysis Booz & Company 090324 FDI Summary Presentation vf.ppt AMCHAM India Friday, 24 April 2009 1 Costs of FDI to Host Countries: Costs of FDI to Host Countries Adverse effects on competition Adverse effects on the balance of payments After the initial capital inflow there is normally a subsequent outflow of earnings Foreign subsidiaries could import a substantial number of inputs National sovereignty and autonomy Some host governments worry that FDI is accompanied by some loss of economic independence resulting in the host countrys economy being controlled by a foreign corporation Political Ideology and FDI: Political Ideology and FDI Radical View Pragmatic Nationalism Free Market Political Ideology & FDI: Political Ideology & FDI The Radical View: The Radical View Marxist view: MNEs exploit less-developed host countries Extract profits Give nothing of value in exchange Instrument of domination, not development Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology The Radical View: The Radical View By the end of the 1980s radical view was in retreat Collapse of communism Bad economic performance of countries that embraced the radical view Strong economic performance of countries who embraced capitalism rather than the radical view The Free Market View: The Free Market View Nations specialize in goods and services that they can produce most efficiently Resource transfers benefit and strengthen the host country Positive changes in laws and growth of bilateral agreements attest to strength of free market view All countries impose some restrictions on FDI Pragmatic Nationalism: Pragmatic Nationalism FDI has benefits and costs Allow FDI if benefits outweigh costs Block FDI that harms indigenous industry Court FDI that is in national interest Tax breaks Subsidies REGIONAL DEVELOPMENT IMPLICATIONS OF FDI : REGIONAL DEVELOPMENT IMPLICATIONS OF FDI Post Communist Eastern Europe, e.g. Czech Automotive Components Foreign direct investment (FDI) has been accorded a central role in the post-communist economic transformation of Central and Eastern Europe. Regional effects of FDI in Central Europe (Czech Republic, Hungary, Poland and Slovakia) in the 1990s. Slide 37: Defining FDIs role in regional economic transformations Intensification of Uneven Development Development of a Dual Economy Failure to Develop Linkages with Local and Regional Economies Contribution to Increased Regional Economic Instability Legal Institutions and FDI: Legal Institutions and FDI Debate over relationship between legal institutions and foreign investment flows Traditional/orthodox view: legal institutions play a crucial role in the process of market-oriented development by protecting private rights, especially the property and contract rights of foreign investors By creating the legal foundations for market-oriented reform