FOREIGN DIRECT

INVESTMENT
JOHANNA C. CLARO-PICHAY, RCh
MPA 2
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
No managerial involvement = portfolio
investment
 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
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

FDI forms
Purchase of assets: why? why not?
Quickentry, local market know-how, local financing may
be possible, eliminate competitor, buying problems
New investment: why? why not?
Nolocal 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
FDI
FDI - 100% ownership
FDI < 100% ownership, International Joint Venture
Strategic Alliances (non-equity)
Franchising
Licensing

Exports: Direct vs Indirect

 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
 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 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
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
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
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
Are transportation costs Import
No No Export
high? Barriers?
Ye
Ye s
s
Is know-how easy to No FDI
license?
Ye
s
Tight control over foreign Yes FDI
ops required?
No

Yes FDI
Is know-how valuable and
is protection possible?
No License