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1 Foreign Direct Investment: a tool for sustained competitive advantage and/or for technology diffusion Foreign Direct Investment: a tool for sustained.

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Presentation on theme: "1 Foreign Direct Investment: a tool for sustained competitive advantage and/or for technology diffusion Foreign Direct Investment: a tool for sustained."— Presentation transcript:

1 1 Foreign Direct Investment: a tool for sustained competitive advantage and/or for technology diffusion Foreign Direct Investment: a tool for sustained competitive advantage and/or for technology diffusion MGTECON 580: Class 4 Definition: acquisition of controlling assets of a firm in another country FDI in perspective is one alternative strategy to internationalize: - exports - licensing - sourcing abroad - distribution subsidiary - production subsidiary - exports - licensing - sourcing abroad - distribution subsidiary - production subsidiary Relation to location theory: One step more complicated Different functions at different location Centrifugal versus centripetal forces; transport costs

2 2 The firm perspective and the country view Strategic importance for firms Lowering costs Increasing market share Diversification Acquiring strategic assets Securing long-run profitability The policy issue (country perspective) There are usually arguments against both types: - Inward investment (IDI) implies “Foreign dominance” specifically in sophisticated, strategic industries - Inward investment implies “development trap” if only low-skill industries come in - “Investing abroad” implies employment loss Old style firm vs. new Old: one region, one country production and demand overlap New: optimizing jointly production, transport, marketing, sourcing

3 3 Technicalities and indicators Investment vs. stocks Flows in a year, stocks accumulated Investment is recorded (via National Bank) Divestment often not, if bankruptcy Acquisition value vs. net addition to stock Buying price (investment) in % of national (physical) investment Alternative indicator: capital stock in % to GNP Sales of a firm can comprise: Sales = SHD + SHF + SAF + SAH Sales at home for domestic market Sales at home for foreign market Sales abroad for foreign market Sales abroad for home market

4 4 The many faces (types) of FDI According to activity Production Production Upward activities (sourcing) Upward activities (sourcing) Distribution, logistic Distribution, logistic Research Research Headquarters Headquarters According to investment mode Greenfield investment Greenfield investment Merger/acquisition Merger/acquisition Joint venture Joint venture Note: portfolio investment (small shares) is not FDI According to motives Cost-driven Cost-driven Market-driven (serve better the market) Market-driven (serve better the market) Infrastructure-driven (business environment) Infrastructure-driven (business environment) According to trade effect Import substituting Import substituting Export increasing Export increasing According to financial transaction Equity capital (share) Equity capital (share) Reinvested earnings Reinvested earnings Intra-company loans Intra-company loans According to firm’s internal structure Horizontal FDI Horizontal FDI Duplicating plans to get rid of tariffs and trade costsDuplicating plans to get rid of tariffs and trade costs In principle substitute to exportsIn principle substitute to exports Vertical FDI Vertical FDI Part of the supply chain is “outsourced”Part of the supply chain is “outsourced” In principle complement to exportsIn principle complement to exports Horizontal FDI Horizontal FDI Duplicating plans to get rid of tariffs and trade costsDuplicating plans to get rid of tariffs and trade costs In principle substitute to exportsIn principle substitute to exports Conglomerate Conglomerate

5 5 The eclectic OLI Model by John Dunning The eclectic OLI Model by John Dunning The basic theoretical challenge Indigenous, domestic firms should have a priori advantage Indigenous, domestic firms should have a priori advantage Knowledge of environment Knowledge of environment Distance HQ -- production site Distance HQ -- production site What compensates this advantage Ownership advantages: firm-specific knowledge Ownership advantages: firm-specific knowledge Patents, expertise of organization and learning Patents, expertise of organization and learning Location advantages: cheaper/better inputs Location advantages: cheaper/better inputs Internalization advantages Internalization advantages Better use inside the firm than through the market (licensing and pricing) Better use inside the firm than through the market (licensing and pricing) OLI paradigm: you need all three

6 6 1st phase: inventionin developed country 2nd phase: growth periodexports 3rd phase: maturityFDI Other determinants of FDI Rate of return difference FDI goes in countries with higher expected return Portfolio diversification: investments to diversify risks Market size attracts investment Product cycle explanation Each product passes three phases: Oligopolistic interaction Investment is a commitment Which puts other firms in worse position Other strategic factors Defend markets, get foothold, complementing, committing Internal financing: free cash flow looks for opportunities Policy related determinants: better business conditions

7 7 Stage 1: No location bound asset At least no created ones, ev. Natural resources At least no created ones, ev. Natural resources Prediction: Neither IDI nor ADI Prediction: Neither IDI nor ADI Five Stage Theory: Net FDI depends on stages of development, by John Dunning Stage 2: Inward FDI attracted by cheap inputs or resources Possibly government helps (involuntarily) with import taxes Possibly government helps (involuntarily) with import taxes Outward investment starts, but well behind inward Outward investment starts, but well behind inward Prediction: FID-deficit Prediction: FID-deficit Stage 3: Upcoming ownership advantages: ADI rises faster than IDI Surpluses with poor countries, deficits with rich ones Surpluses with poor countries, deficits with rich ones Prediction: FDI stock becomes balanced Prediction: FDI stock becomes balanced Stage 4: Ownership advantages and search for low cost production sites Further push outward investment up to maximum surplus Further push outward investment up to maximum surplus Intra-industry production specialization (following IIT shares) Intra-industry production specialization (following IIT shares) Prediction: high-surplus of ADI, both flows increasing Prediction: high-surplus of ADI, both flows increasing Stage 5: Firms become globalized and nationalities blurred (Dunning-Narula, p8) But there can be instable positions (fluctuations, vicious and virtuous circles) But there can be instable positions (fluctuations, vicious and virtuous circles) Prediction: Net positions equalize again Prediction: Net positions equalize again

8 8 Empirics of FDI Stylized fact 1: FDI growth higher than trade and GNP growth Stylized fact 2: Significant share of trade is intra-firm trade Stylized fact 3: FDI is investment of developed countries in developed countries Stylized fact 4: There are industry differences Hierarchy of dynamics 1985 - 97: (UNCTAD FDI/TNC Database Nominal GDP7% Trade by9% FDI inflow18% 1998 - 30% of world trade is trade in commodities within firms (Yeats p.16) High share from neighbors Much intra EU A lot from US 18% of employees in EU work in MNE 8.6% owned by non-EU parents 7% in US parents High FDI sectors are R&D intensive Skill intensive Technically sophisticated, differentiated Peak of US firm shares in Europe Optical and medical instruments17% Transportation14% Chemicals12% Telecom10% Peak of EU in US are Chemicals36% Glass, stone18% Electronics14%

9 9 Stylized fact 5: In bilateral investment EU has a substantial surplus, high overlap Stylized fact 6: Developing countries are recipient: IDI: ADI=4:1 Stylized fact 7: Developing countries receive minority of FDI (30%) Stylized fact 8: EU is net investor in FDI, as well as a net export in trade US firms in EU are responsible for 22% of EU imports from US and 19% of EU exports to US EU firms in US are responsible for 28% of US imports from EU and 12% of US exports to EU Interpretations: EU “needs more home input” 35% of EU and 47% of US imports (share of bilateral flows) However, relative to GDP now more (2.4%) than developed 1.3% (p13) Stylized fact 9: US are marginally a net investor in FDI, net importer in trade Stylized fact 10: Japan is a net investor, though with low flows and less surplus than in trade

10 10 Does actual pattern of FDI follow Five Stage Theory? Deficit in stage 2 is empirically shown FDI deficit in developing countries FDI deficit in developing countries And in GR, P, SP And in GR, P, SP Increasing outward investment in stage 3 also But to different extent But to different extent Deficit depends on natural resources vs. firm specific advantages Deficit depends on natural resources vs. firm specific advantages Country specific persistency in phase 4 See European countries: See European countries: UK and Switzerland have persistent investment surplus UK and Switzerland have persistent investment surplus Austria a persistent deficit (never a surplus in between)… Austria a persistent deficit (never a surplus in between)… Equalization in phase 5 is open question US has still a surplus (decreasing) US has still a surplus (decreasing) Japan has a large non-decreasing surplus Japan has a large non-decreasing surplus What is behind? High wage in Switzerland High wage in Switzerland Financial center, research and other attractions for headquarters Financial center, research and other attractions for headquarters Headquarters move only for significant cost-service differences Headquarters move only for significant cost-service differences

11 11 Conclusions: FDI activists in Europe: UK, Netherlands, Sweden, D,F,SF,S,I These are all big 4 plus the Nordic FDI receivers all south (exception Italy) plus Austria (A-D); Belgium (B:NI) Sp less than expected see SP-P Inward and outward investment across countries

12 12 The impact of FDI on economic development Positive: Quickest import of technology and management Quickest import of technology and management High productivity, cheap products High productivity, cheap products Learning to catch up in skills Learning to catch up in skills Negative: Host country may get second best technology Host country may get second best technology Development trap (MNE invest in industry with low future potential) Development trap (MNE invest in industry with low future potential) Plants not fitting into endogenous development Plants not fitting into endogenous development Footloose industries stay only as long as costs are low Footloose industries stay only as long as costs are low Outside steering of development, dictated by headquarter Outside steering of development, dictated by headquarter Important for a positive contribution to host country: Linkages, Learning, Upgrading as shown in the Irish example Linkages, Learning, Upgrading as shown in the Irish example Open for inward FDI plus upgrading infrastructure Open for inward FDI plus upgrading infrastructure And inviting firms to upgrade plant Focus on linkages Focus on linkages On learningOn learning On small local firms interrelating with MNEOn small local firms interrelating with MNE

13 13 Empirical facts about behavior of MNE Empirical facts about behavior of MNE Labor-intensive sectors dominate Capital-intensive sectors Human capital-intensive industries underrepresented Many IDI have few linkages (insolated firms) MNE plants have high productivity Fast growing Technology transfer, however, not own research Countries pursuing export lead perform better Than countries relying on import substitution strategies

14 14 The impact of FDI on economic development The rationale for FDI Lowering costs (road to cost leadership) Lowering costs (road to cost leadership) Increasing market share (size, barriers to entry, strategic advantage Increasing market share (size, barriers to entry, strategic advantage Diversification (new market, distributing fixed costs of firm specific asset or capability) Diversification (new market, distributing fixed costs of firm specific asset or capability) Acquiring strategic assets (innovative capacity of foreign firm, country) Acquiring strategic assets (innovative capacity of foreign firm, country) Long-run profitability Long-run profitability Chances To evade the eternal threat of profit dissipation (the need for markets) To evade the eternal threat of profit dissipation (the need for markets) To reduce costs (the need of evading high costs) To reduce costs (the need of evading high costs) To increase world market share (the need of top 3 position) To increase world market share (the need of top 3 position) To shift into fast growing countries To shift into fast growing countries To acquire strategic assets and capabilities (IT, knowledge) To acquire strategic assets and capabilities (IT, knowledge) Risks Specific country risk (political, legal) Specific country risk (political, legal) Difference in culture and corporate governance Difference in culture and corporate governance Different scheme of wages, social contributions, taxes Different scheme of wages, social contributions, taxes Danger that competitive advantage can not be transferred, sustained Danger that competitive advantage can not be transferred, sustained Danger that resources will be diverted from investing into sustaining competitive advantage Danger that resources will be diverted from investing into sustaining competitive advantage Specific problem of control (size, distance) Specific problem of control (size, distance) And organization (decentralization, centralization, divisional, functional)

15 15 The implementation in formal mode (A1) FDI:fixed cost at headquarter (once): F lower variable costs (relative to domestic firms): c.q, c { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/14/4231941/slides/slide_15.jpg", "name": "15 The implementation in formal mode (A1) FDI:fixed cost at headquarter (once): F lower variable costs (relative to domestic firms): c.q, c


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