Foreign Direct Investment What Is FDI? Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country the firm becomes a multinational enterprise FDI can be in the form of greenfield investments - the establishment of a wholly new operation in a foreign country acquisitions or mergers with existing firms in the foreign country
8-3 What Is FDI? The flow of FDI - the amount of FDI undertaken over a given time period Outflows of FDI are the flows of FDI out of a country Inflows of FDI are the flows of FDI into a country The stock of FDI - the total accumulated value of foreign-owned assets at a given time 8-4 What Are The Patterns Of FDI? The growth of FDI is a result of 1. a fear of protectionism want to circumvent trade barriers 2. political and economic changes deregulation, privatization, fewer restrictions on FDI 3. new bilateral investment treaties designed to facilitate investment 4. the globalization of the world economy many companies now view the world as their market need to be closer to their customers
8-5 What Are The Patterns Of FDI? Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like So, FDI is an important source of capital investment and a determinant of the future growth rate of an economy
8-6 Why Do Firms Choose Acquisition Versus Greenfield Investments? Firms prefer to acquire existing assets because mergers and acquisitions are quicker to execute than greenfield investments it is easier and perhaps less risky firms believe that they can increase the efficiency
8-7 Why Choose FDI? Question: Why does FDI occur instead of exporting or licensing? 1. Exporting - producing goods at home and then shipping them to the receiving country for sale exports can be limited by transportation costs and trade barriers FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas
8-8 Why Choose FDI? 2. Licensing - granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells Internalization theory (aka market imperfections theory) - compared to FDI licensing is less attractive firm could give away valuable technological know- how to a potential foreign competitor does not give a firm the control over manufacturing, marketing, and strategy in the foreign country the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities
8-9 What Are The Theoretical Approaches To FDI? The radical view - the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries in retreat almost everywhere The free market view - international production should be distributed among countries according to the theory of comparative advantage embraced by advanced and developing nations including the United States and Britain, but no country has adopted it in its purest form
8-10 How Does FDI Benefit The Host Country? There are four main benefits of inward FDI for a host country 1. Resource transfer effects - FDI brings capital, technology, and management resources 2. Employment effects - FDI can bring jobs 3. Balance of payments effects - FDI can help a country to achieve a current account surplus 4. Effects on competition and economic growth - greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers can lead to increased productivity growth, product and process innovation, and greater economic growth
8-11 What Are The Costs Of FDI To The Host Country? Inward FDI has three main costs: 1. Adverse effects of FDI on competition within the host nation subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization 2. Adverse effects on the balance of payments when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments 3. Perceived loss of national sovereignty and autonomy decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control
8-12 How Does FDI Benefit The Home Country? The benefits of FDI for the home country include 1. The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings 2. The employment effects that arise from outward FDI 3. The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
8-13 What Are The Costs Of FDI To The Home Country? 1. The home country’s balance of payments can suffer from the initial capital outflow required to finance the FDI if the purpose of the FDI is to serve the home market from a low cost labor location if the FDI is a substitute for direct exports
8-14 What Are The Costs Of FDI To The Home Country? 2. Employment may also be negatively affected if the FDI is a substitute for domestic production But, international trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid may stimulate economic growth and employment in the home country by freeing resources to specialize in activities where the home country has a comparative advantage
8-15 How Does Government Influence FDI? Governments can Governments can encourage encourage outward FDI inward FDI government-backed offer incentives to foreign firms insurance programs to to invest in their countries cover major types of gain from the resource-transfer foreign investment risk and employment effects of FDI, and capture FDI away from other potential host countries Governments can restrict outward FDI limit capital outflows, Governments can restrict manipulate tax rules, or inward FDI outright prohibit FDI use ownership restraints and performance requirements
8-16 What Does FDI Mean For Managers? A Decision Framework
