Global Business Management (MGT380) Lecture #8: Foreign Direct Investment

Learning Objectives Identify the forces underpinning the rising tide of foreign direct investment in the world economy Understand why firms often prefer direct investment as a strategy for entering foreign market over alternatives such as exporting and granting foreign entities the right to produce product under license. Understand the importance of location for FDI

Quick recap of last lecture Assumption of competitive advantage theory: The simple example of comparative advantage makes a number of assumptions: only two countries and two goods; zero transportation costs; similar prices and values; resources are mobile between goods within countries, but not across countries; constant returns to scale; fixed stocks of resources; and no effects on income distribution within countries. The Samuelson Critique: Samuelson argues that 1) Resources do not always move freely from one economic activity to another. 2) the ability to offshore services jobs that were traditionally not internationally mobile may have the effect of a mass inward migration into the United States, where wages would then fall. Studies exploring the relationship between trade and economic growth suggest that countries that adopt a more open stance toward international trade enjoy higher growth rates than those that close their economies to trade. Trade increase stock of resources, Trade increase the efficiency(technology, competition, economy of scale)

Heckscher and Ohlin argued that comparative advantage arises from differences in national factor endowments . Relative not Absolute. In 1953, Wassily Leontief postulated that since the U.S. was relatively abundant in capital compared to other nations, the U.S. would be an exporter of capital intensive goods and an importer of labor-intensive goods. However, he found that U.S. exports were less capital intensive than U.S. imports (exporting labor-intensive). In the mid-1960s, Raymond Vernon proposed the product life-cycle theory that suggested that as products mature both the location of sales and the optimal production location will change affecting the flow and direction of trade. Economies of Scale, First Mover Advantages, and the Pattern of Trade

Porter’s 1990 study tried to explain why a nation achieves international success in a particular industry and identified four attributes that promote or impede the creation of competitive advantage: Factor Endowments: A nation's position in factors of production can lead to competitive advantage, natural resources or human capital Demand Conditions: The nature of home demand for the industry’s product or service influences the development of capabilities. Sophisticated and demanding customers pressure firms to be competitive. Relating and Supporting Industries: The presence supplier industries and related industries that are internationally competitive can spill over and contribute to other industries Firms strategy, structure, and rivalry: The conditions in the market determining how companies are created, organized, and managed and nature of domestic rivalry.

Assignment #1 Question #1 “Mercantilism is a bankrupt theory that has no place in the modern world.” Briefly explain your answer. Question #2 Unions in developed nations often oppose imports from low-wage countries and advocate trade barriers to protect jobs from what they often characterize as “unfair” import competition. Is such competition “unfair?” Do you think that this argument is in the best interests of the unions, the people they represent, the country as a whole

Assignment#2 Is there is a difference between the transference of high paying white collar jobs, such as computer programming and accounting, to developing nations, and low paying blue collar jobs? If so, what is the difference, and should government do anything to stop the flow of white- collar jobs out of the country to countries like India? You may provide your suggestions in bullet points.

Critical thinking question The world’s poorest countries are at a competitive disadvantage in every sector of their economies. They have little to export. They have no capital; their land is of poor quality; they often have too many people given available work opportunities; and they are poorly educated. Free trade cannot possibly be in the interests of such nations! .

Management Focus: The Rise of Finland’s Nokia Summary: This feature is about the growth of the cellular telephone equipment industry, and more specifically, about the rise in competitiveness of Nokia, a Finnish cellular telephone company. The feature explains the reasons that Nokia was particularly well positioned to take advantage of the growth of the global cellular telephone industry. Suggested Discussion Questions 1. Using the New Trade Theory and Porter’s theory of National Competitive Advantage, describe why Nokia emerged as a leading competitor in the global cellular telephone equipment industry. 2. Explain why the cellular telephone industry caught on in Finland and the other Scandinavian countries faster than the rest of the world. 3. Why didn’t the development of the cellular telephone equipment industry take place in Mexico or another Central or South American country rather than Finland, Sweden, and the United States? Base your answer of the international trade theories described in this chapter.

How to define FDI Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country the firm becomes a multinational enterprise FDI can be in the form of greenfield investments - the establishment of a wholly new operation in a foreign country acquisitions or mergers with existing firms in the foreign country The flow of FDI refers to the amount of FDI undertaken over a given time period Outflows of FDI are the flows of FDI out of a country Inflows of FDI are the flows of FDI into a country The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time

Patterns of FDI Both the flow and stock of FDI have increased over the last 30 years Most FDI is targeted towards developed nations - United States and EU South, East, and South East Asia - China – and Latin America are emerging FDI has grown more rapidly than world trade and world output firms still fear the threat of protectionism democratic political institutions and free market economies have encouraged FDI globalization is forcing firms to maintain a presence around the world Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like the greater the capital investment in an economy, the more favorable its future prospects are likely to be So, FDI is an important source of capital investment and a determinant of the future growth rate of an economy

Why has there been such a significant increase in FDI outflows? There are several reasons for this pattern. Firms are worried about protectionist measures, and see FDI as a way of getting around trade barriers. Changes in the economic and political policies of many countries have opened new markets to investment. Think, for example of the changes in Eastern Europe that have made it possible for foreign firms to expand there. Third, many firms see the world as their market now, and so are expanding wherever they feel it makes sense. Spain’s Telefonica is pursuing opportunities in Latin America and in Europe. 4. Many manufacturers are expanding into foreign countries to take advantage of lower cost labor, or to be closer to customers, and so on. China has become a hot spot for firms that are attracted to the country’s low wage rates, and large market.

What Are The Patterns Of FDI?

What Are The Patterns Of FDI?

What Are The Patterns Of FDI?

What Is The Source Of FDI? Since World War II, the U.S. has been the largest source country for FDI the United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries together, these countries account for 56% of all FDI outflows from 1998-2006, and 61% of the total global stock of FDI in 2007

Sources of FDI

Why Do Firms Choose Acquisition Versus Greenfield Investments? Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments Firms prefer to acquire existing assets because mergers and acquisitions are quicker to execute than greenfield investments it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

Why Does FDI In Services Occur? FDI is shifting away from extractive industries and manufacturing, and towards services The shift to services is being driven by the general move in many developed countries toward services the fact that many services need to be produced where they are consumed a liberalization of policies governing FDI in services the rise of Internet-based global telecommunications networks

Does FDI always involve only manufacturing? Over the last 20 years or so, there’s been a shift away from some of the traditional industries toward FDI in services. In 2006, for example, about two thirds of the stock of FDI was in services! There are four main reasons for the shift. First, there is a general trend in developed countries away from manufacturing and toward services. Second, because services often have to be produced where they are consumed, FDI is required. After all, you can’t ship a hot latte from Seattle to Beijing! Third, there has been a liberalization of policies governing services. Brazil for example, opened its telecommunications sector to foreign companies in the 1990s. Finally, Internet-based global telecommunications now allow companies to shift activities like call centers to low cost locations like India.

Why Choose FDI? Exporting - producing goods at home and then shipping them to the receiving country for sale exports can be limited by transportation costs and trade barriers FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas Licensing - granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells Internalization theory (aka market imperfections theory) suggests that licensing has three major drawbacks compared to FDI firm could give away valuable technological know-how to a potential foreign competitor. RCA (US firm) licensed its color-technology to Japanese firms to Sony. does not give a firm the control over manufacturing, marketing, and strategy in the foreign country the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities. Toyota competitive advantages (management & process capabilities) embedded in its culture

Internalization theory (aka market imperfections theory) suggests that exporting has two major drawbacks compared to FDI Transportation cost (location, low value-weight products, high value-weight products) Trade barriers

Wal-Mart’s FDI

Summary of the lecture Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country the firm becomes a multinational enterprise FDI can be in the form of: greenfield investments - the establishment of a wholly new operation in a foreign country: acquisitions or mergers with existing firms in the foreign country The flow of FDI refers to the amount of FDI undertaken over a given time period The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like

FDI has grown more rapidly than world trade and world output firms still fear the threat of protectionism democratic political institutions and free market economies have encouraged FDI globalization is forcing firms to maintain a presence around the world There are several reasons for this pattern. 1) Firms are worried about protectionist measures, and see FDI as a way of getting around trade barriers. 2) Changes in the economic and political policies of many countries have opened new markets to investment. Think, for example of the changes in Eastern Europe that have made it possible for foreign firms to expand there. 3)Third, many firms see the world as their market now, and so are expanding wherever they feel it makes sense. Spain’s Telefonica is pursuing opportunities in Latin America and in Europe. 4) Many manufacturers are expanding into foreign countries to take advantage of lower cost labor, or to be closer to customers, and so on. China has become a hot spot for firms that are attracted to the country’s low wage rates, and large market.

Firms prefer to acquire existing assets because mergers and acquisitions are quicker to execute than greenfield investments it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills Export/ License vs. FDI Internalization theory suggests that licensing has three major drawbacks compared to FDI i) firm could give away valuable technological know-how to a potential foreign competitor. RCA (US firm) licensed its color- technology to Japanese firms to Sony. (ii) does not give a firm the control over manufacturing, marketing, and strategy in the foreign country (iii) the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities. Toyota competitive advantages (management & process capabilities) embedded in its culture

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