1. Foreign Direct Investment and Political Risk
International Financial Management
Dr. A. DeMaskey

2. Learning Objectives How do firms become multinational?
Why do firms locate production overseas?
What is country risk? Political risk?
How do we measure political risk?

3. How Do Firms Become MNCs?
Exporting/Importing
Licensing
Franchising
Joint Ventures
Acquisitions
De Novo Start Up
Low Risk/Low Return Strategy (early phase) (intermediate phase)
High Risk/High Return Strategy (advanced phase)
Foreign Direct Investment

4. Global Trends in FDI Total annual worldwide FDI flows of $830 billion
FDI Outflows
Strong preference to invest in developed countries
Biggest targets are U.K. and Germany
Comparative advantages
FDI Inflows
U.S. is an attractive source of FDI
Other popular destinations include China, Mexico, and Spain
Locational advantages

5. Why Do Firms Invest Overseas?
Market Imperfections (Kindleberger (1969) and Hymer (1975))
Imperfections in
Product Markets
Factor Markets
Capital Markets

6. Key Factors in Locating Production Overseas
Trade Barriers
Imperfect Labor Markets
Intangible Assets
Vertical integration
Product Life Cycle
Capital Market Imperfections
Market Failure Imperfections

7. Hourly Labor Costs in the Manufacturing Sector (2001)

8. Political Risk and FDI
Risk of loss to the parent firm due to adverse political developments in the host country.
Outright expropriation
Unexpected changes in tax laws

9. Types of Political Risk
Depending on incidence:
Macro risk
Micro risk
Depending on manner:
Transfer risk
Operational risk
Control risk

10. Examples of Political Risk
China in 1949
Cuba in 1960
Egypt in the early 1950s

11. Key Factors in Political Risk Analysis
Host country’s political and government system
Track records of political parties and their relative strength
Integration into the world system
Host country’s ethnic and religious stability
Regional security
Key economic indicators
Capital flight
POR
Index

12. Measuring Political Risk
In-house experts
Outside experts;
Morgan Stanley provides in-depth analysis of country/political risks
Euromoney provides country ratings by
Political risk
Credit risk
Economic performance

13. Economic and Political Factors Underlying Country Risk
Fiscal irresponsibility
Monetary instability
Controlled exchange rate system
Wasteful government spending
Quality of natural, human, and financial resources
Adjustment to external shocks
Market-oriented vs. statist policies

14. Useful Web Sites for Assessing Country Risk
What are the political and financial outlook for various countries?
Consult the Country Commercial Guides prepared by embassy staff at
Refer to the CIA’s World Factbook at
Visit
More …

15. Useful Web Sites for Assessing Country Risk
How risky is your country? Look up: