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Foreign Direct Investment.  Why is FDI increasing in the world economy?  Why do firms often prefer FDI to other market entry strategies?  Why do.

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Presentation on theme: "Foreign Direct Investment.  Why is FDI increasing in the world economy?  Why do firms often prefer FDI to other market entry strategies?  Why do."— Presentation transcript:

1 Foreign Direct Investment

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3  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?

4 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

5 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

6 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

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8 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

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10 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

11 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

12 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

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14 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

15 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 MNC’s boundaries

16 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 economy’s comparative advantages

17 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

18 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 country’s interests

19 Decision Framework for FDI Export FDI License Yes Import Barriers? 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 Ye s No Ye s

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