Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 1 Chapter 4: Foreign Direct Investment: Practice and Theory FDI Outflows FDI Inflows FDI Outward stock Sectoral trends Geographic trends The Trojan Horse?

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 2 TOPIC PLAN: l Determinants of Foreign Direct Investment(FDI) l FDI Concepts »FDI Outflows/FDI Inflows »Outward & Inward FDI Stock »Mergers and Acquisitions l Sectoral Distribution of FDI l Theories of FDI: Global Horizons; The International Product Cycle; Internalisation

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 3 Foreign Direct Investment (FDI) l An investment involving management control of a resident entity in one economy (THE HOST COUNTRY), by an enterprise in another economy (THE HOME COUNTRY). l FDI involves a long-term relationship reflecting an investor’s lasting interest in a foreign entity. The investor=The PARENT firm and the foreign entity/asset= the “affiliate” (“subsidiary”)

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 4 Average annual growth rate,World FDI Outflows, Exports of Goods & Services, GDP

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 5 Flow vs. Stock of FDI l Flow: Amount of FDI over a period of time (one year). l Stock: Total accumulated value of foreign owned assets at a given point in time.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 6 Other FDI concepts l FDI FLOWS (Outflows, Inflows) l FDI Stock (Outward, Inward) l “Greenfield” investment = new investment made up by setting up a new affiliate overseas l Cross border M&As (Mergers and Acquisitions)= acquisition of more than 10% equity share of an existing operation overseas. » Mergers=the combining of two or more firms » Acquisition/take-over of an existing operation

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 7 M&As vs. Greenfield Investments l At the time of entry and in the short term M&As may involve smaller benefits or larger negative impacts from the perspective of host-country development »financial resources do not always add to stock »Less likely to transfer new technologies and skills »does not generate employment (possible lay-offs) »can increase concentration and lessen competition l However, in the long term many differences diminish or disappear

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 8 M&As vs. Greenfield Investments l UNCTAD’s World Investment Report 2000 concludes that, under normal circumstances, Greenfield FDI is more useful, in terms of its developmental impact, to host countries than cross- border M&As. l However, under exceptional circumstances (e.g. economic crisis) cross-border M&As can play a useful role

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 9 M&As vs. Greenfield Investments l UNCTAD’s World Investment Report 2000 concludes that, under normal circumstances, Greenfield FDI is more useful, in terms of its developmental impact, to host countries than cross- border M&As. l However, under exceptional circumstances (e.g. economic crisis) cross-border M&As can play a useful role

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 10 Determinants of Foreign Direct Investment l Trade restrictions (the “Trojan horse"). l Cost/profitability factors l Investment climate l Marketing factors

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 11 Trade restrictions (the “Trojan horse"). l Barriers to trade l Preference of local customers for local products.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 12 Cost/profitability Factors l Cheaper production costs (labour, materials) l Cheaper infrastructure (electricity, telecom) l Lower rental costs (commercial, residential) l Expected higher profits. l Desire to be near source of supply.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 13 Investment Climate l Government attitude toward foreign investment (e.g. incentives) l Political stability l Limitations on ownership l Currency exchange regulations l Stability of foreign exchange l Tax structure

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 14 Geographic Distribution of FDI Outflows, ,% of total

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 15 The Top 10 sources of Outward FDI in 2000, % of world total

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 16 Geographic Distribution of FDI Inflows, ,% of total world

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 17 Shares of leading 5 economies in inward FDI stock in 1980,2000

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 18 Sectoral Distribution of FDI Inward Stock, 1988, 1999 Developing Countries Sector Primary Secondary Tertiary Unspecified Developed Countries Sector Primary Secondary Tertiary Unspecified

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 19 FDI benefits/costs to Host countries l Benefits: »Capital »Technology »Management »Employment »Exports »Current Account(?) l Costs »Adverse effects on competition »Adverse effects on the Balance of Payments »Concerns about national sovereignty

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 20 FDI benefits to Home countries l Improves balance of payments l Positive employment effects »Export demand can create jobs. l Increased knowledge from operating in a foreign environment. l Benefits the consumer through better products and lower prices.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 21 FDI costs to Home countries l Negative effect on Balance of Payments »Initial capital outflow (offset by subsequent inflows). »Multinational Enterprise (MNE) uses foreign subsidiary to sell back to home market. »MNE uses foreign subsidiary as a substitute for direct exports (loss of export earnings). l Potential “export” of jobs.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 22 FDI and International Trade l The relationship between trade and FDI in a given product is characterised by a sequential process of internationalisation, e.g. trade to FDI or FDI to trade l Subsidiaries source goods and services from parent companies and can do exports from the host country l FDI is not only a source of capital but also of new technology, managerial skills and marketing networks.

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 23 Exports of foreign affiliates as % of total exports in the primary & secondary sector -Various years-

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 24 Foreign Direct Investment Theories l The Global Horizons Theory l The International Product Cycle l The Internalisation Theory

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 25 The Global Horizons Theory l Internal forces : » The influence of a high executive » The need to market a new technology//product » Finding use for old equipment. » The observed need for a larger market. » Mergers/Acquisitions (e.g.BHP-Utah International) l External forces » Influence of customers » Initiative of foreign government » Foreign expansion of a competitor » Dramatic event (e.g.formation of a free-trade area ) l

Fig.4.4:International Product Cycle Innovating country (e.g. US, Japan) Other Industrial countries Developing Countries Time Stages of Production Development New ProductStandardized ProductMaturing Product QuantityQuantity production consumption 2 Imports Exports Imports Exports Imports

Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment by John Gionea Slides prepared by John Gionea 27 The Internalisation Theory l Internalisation:The extension of ownership by a firm to cover new markets,new sources of materials and new stages of the production process. l Horizontal / vertical integration l MNE accomplishes an international transfer of factors,services and goods more efficiently than external markets l MNE-An institution designed to create and exploit internal markets.