INTERNATIONAL BUSINESS CHAPTER VII FOREIGN DIRECT INVESTMENT

Learning Objectives Describe the worldwide patterns of foreign direct investment (FDI) and the reasons for these patterns. Describe each of the theories that attempt to explain why foreign direct investment occurs. Discuss the important management issues in the foreign direct investment decision. Explain why governments intervene in the free flow of foreign direct investment. Discuss the policy instruments that governments use to promote and restrict foreign direct investment.

FOREIGN DIRECT INVESTMENT PORTFOLIO INVESTMENT The purchase of physical assets or a significant amount of the ownership (stock) of a company in another country to gain a measure of management control. Investment that does not involve obtaining a degree of control in a company.

I. PATTERNS OF FOREIGN DIRECT INVESTMENT Ups and Downs of Foreign Direct Investment Worldwide Flows of FDI

1.1 Ups and Downs of Foreign Direct Investment (FDI) Globalization Mergers and Acquisitions Role of Entrepreneurs and Small Businesses

1.1.1 Ups and Downs of Foreign Direct Investment (FDI) Globalization Companies were trying to export their products to markets around the world  Wave of FDI Another wave of FDI flows into low-cost newly industrialized & emerging nations worldwide.

1.1.2 Ups and Downs of Foreign Direct Investment (FDI) Mergers and Acquisitions The number of Mergers and Acquisitions and their exploding values also underlie long-term growth in FDI

1.1.2 Ups and Down of Foreign Direct Investment Mergers and Acquisitions Many cross-border merger and acquisitions deals are driven by the desire of companies to do any or all of the following: Get a foothold in a new geographic market Increase a firm’s global competitiveness Fill gaps in companies’ product lines in a global industry Reduce costs in areas such as research and development, production, or distribution

1.1.3 Ups and Down of Foreign Direct Investment Role of Entrepreneurs and Small Businesses these companies are engaged in FDI

1.2 Worldwide Flows of FDI Developed countries account for around 70% Developing countries account for 30%

II. EXPLAINATIONS FOR FOREIGN DIRECT INVESTMENT International Product Life Cycle Market Imperfections (Internalization) Eclectic Theory Market Power

II.1 International Product Life Cycle Theory stating that a company will begin by exporting its product and later undertake foreign direct investment as a product moves through its life cycle

II.2 Market Imperfection (Internalization) Theory stating that when an imperfection in the market makes a transaction less efficient than it could be, a company will undertake foreign direct investment to internalize the transaction and thereby remove the imperfection

II.2 Market Imperfection (Internalization) Trade Barriers One common market imperfection in international business, such as Tariffs Specialized Knowledge The unique competitive advantage of company sometimes consists of Specialized Knowledge

II.3 Eclectic theory Eclectic theory Theory stating that firms undertake foreign direct investment when the features of a particular location combine with ownership and internalization advantages to make a location appealing for investment

II.5 Market power Market power Theory stating that a firm tries to establish a dominant market presence in an industry by undertaking foreign direct investment

II.5 Market power Vertical integration Extension of company activities into stages of production that provide a firm’s inputs ( backward integration ) or absorb its output ( forward integration )

III. MANAGEMENT ISSUES IN THE FDI DECISION Control Purchase- or- Build Decision Production Costs Customer Knowledge Following Clients Following Rivals

III.1 Control Control Partnership Requirements Benefits of Cooperation

III.1.1 Partnership Requirements Because of the importance of control Many companies have strict policies regarding how much ownership they will take in firms in other nations

III.1.2 Benefits of Cooperation Have seen greater harmony between governments and international companies Governments of many developing and newly industrialized countries have come to realize the benefits of investment by multinationals.

III.2 Purchase-or- Build Decision Whether to purchase an existing business or to build a subsidiary abroad from the ground up- call a greenfield investment.

III.3 Production costs Rationalized Production System of production in which each of a product’s components is produced where the cost of producing that component is lowest Cost of Research and development lead multinationals to engage in cross-border alliances and acquisitions.

III.4 Customer Knowledge The behavior of buyers is an important issue in the decision of whether to undertake FDI A local presence can help companies gain valuable knowledge about customers that could not be obtained in the home market.

III.5 Following Clients Firms engage in FDI when doing so puts them close to firms for which they act as a suppliers This practice of “following clients” can be expected in industries in which many component parts are obtained from suppliers with whom a manufacturer has a close working relationship.

III.6 Following Rivals Many firms believe that choosing not to make a move parallel to that of the “first mover” might result in being shut out of a potentially lucrative market.

IV. GOVERNMENT INTERVENTION IN FDI Balance of Payments Reasons for intervention by the host country Reasons for intervention by the home country

IV.1 Balance of Payments Balance of Payments A national accounting systems that records all payments to entities in other countries and all receipts coming into the nation

IV.1 Balance of Payments Current account National account that records transactions involving the import and export of goods and services, income receipt on assets abroad, and income payment on foreign assets inside the country

IV.1 Balance of Payments Current account surplus When a country exports more goods and services and receives more income from abroad than it imports and pays abroad

IV.1 Balance of Payments Current account deficit When a country imports more goods and services and pays more abroad than it exports and receives from abroad

IV.1 Balance of Payments Capital account A national account that records transactions involving the purchase or sale of assets

IV.2 Reasons for Intervention by the Host Country Balance of Payments FDI inflows are recorded as additions to the balance of payments Local production Exports  host country’s balance of payment Obtain Resources and Benefits Access to technology Management skills and employment.

IV.3 Reasons for Intervention by the Home Country Investing in other nations sends resources out of the home country Outgoing FDI may ultimately damage a nation’s Balance of Payments by taking the place of its exports Jobs resulting from outgoing investments may replace jobs at home

IV.3 Reasons for Intervention by the Home Country… Outward FDI can increase long term competitiveness Nations may encourage FDI in industries that they have determined to be “sunset” industries.

V. GOVERNMENT POLICY INSTRUMENTS & FDI Host Countries: Restriction Host Countries: Promotion Home Countries: Restriction Home Countries: Promotion

V.1 Host Countries: Restriction Host countries have a variety of methods to restrict incoming FDI Ownership restriction Performance demands

V.1 Host Countries: Restriction Ownership restriction Government can impose ownership restrictions that prohibit nondomestic companies from investing in certain industries. Performance demands Influence how international companies operate in the host nation

V.2 Host Countries: Promotion Financial incentive Lower tax rates Offers to waive taxes on local profits for a period of time extending as far out as five years or more Infrastructure improvements Better seaports suitable, improved roads, increased telecommunications systems.

V.3 Home Countries: Restriction Impose differential tax rates That charge income from earning abroad at a higher rate than domestic earning Impose outright sanctions That prohibit domestic firms from making investment in certain nations.

V.4 Home Countries: Promotion Offer insurance to cover the risks of investment abroad Grant loans to firms wishing to increase their investment abroad Offer tax breaks on profits earned abroad or negotiate special tax treaties Apply political pressure on other nations to get them to relax their restrictions on inbound investment.

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