Foreign Direct Investment

Foreign Direct Investment

Why is FDI increasing in the world economy? Why do firms often prefer FDI to other market entry strategies? Why do firms imitate competitors with FDI strategies? Why are certain locations favored for FDI? How does political ideology affect government FDI policy? What are key FDI related costs and benefits for receiving and source countries?

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

Factors which influence FDI are related to factors that stimulate trade

Foreign Direct Investment

Involves ownership of entity abroad for
production

Marketing/service
R&D Access of raw materials or other resource

Parent has direct managerial control

Depending on its extent of ownership and On other contractual terms of the FDI

internalization
market failures (such as information costs, opportunism and asset specificity) are the main reason an MNE must use direct investment instead of licensing. An MNE with technological or marketing know-how has firm-specific advantages which are protected within its internal market. An MNE seeks expansion by direct investment when it has competitive advantages over other firms and the firm specific advantage needs to be protected by its organizational structure,

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

Forms of FDI
FDI forms
Purchase of assets:
Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems

New investment:
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

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

Eclectic paradigm for FDI detail OLI

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)

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

Host Country Effects of FDI

Benefits Resource -transfer Employment Balance-of-payment (BOP)
Import substitution

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

MarketingReasons in brief FDI

Product upgradation and living style amelioration also ( product innovation) Price benefits ( low price world class quality) Promotion creativity and quality discounts Healthy compitition and modern distribution system Other benefits ( employment, technology)