1. Foreign Direct Investment
This is a test
GEETA SHIROMANI
ASSOCIATE PROFESSOR

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

3. 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

4. FDI - Flow versus stock
FDI occurs when a firm invests directly in facilities to produce and/or market a product in a foreign country
Flow: Amount of FDI over a period of time (one year)
Stock: Total accumulated value of foreign owned assets at a given point of time
FDI is not the investment by individuals, firms or public bodies in foreign financial instruments

5. Why is FDI important ? Firms want a presence in foreign markets
Firms want control over growth of these foreign markets
To gain first mover advantages
To ward off competitors
To determine locations, advertising and other related strategic decisions in the firm’s interest

6. Trends in FDI Flow and stock increased in the last 30 years
In spite of decline of trade barriers, FDI has grown more rapidly than world trade because:
Businesses fear protectionist pressures
FDI is seen as a way of circumventing trade barriers
Dramatic political and economic changes in many parts of the world
Globalization of the world economy has raised the vision of firms who now see the entire world as their market

7. FDI Growth in the World Economy
FDI Outflow: $35 billion in ‘75 to $1.3 trillion in ‘00 to $620 billion in ‘04
FDI Flow (from all countries): from ‘92 to ‘04 up 260%, compared to trade up 100% and world output up 32%
FDI Stock: $3.5 trillion by ‘97 to more than $ 8.1 trillion in ‘03
In ‘03:
61,000 MNEs had:
9,00,000 foreign affiliates
54 million employees
$17.6 trillion in global sales
$9.2 trillions global exports
Conclusion: FDI flow growing faster than world trade and world output

8. FDI- inflows & outflows

9. 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

10. Inflows in developed vs. developing countries

11. Outflows in developed vs. developing countries

12. FDI trends:
The value of FDI slumped almost 60 percent in
Slowdown in world economy
Heightened geopolitical uncertainty since September 11, 2001
Bursting of the stock market bubble in the US

13. Developed countries- FDI outflows

14. Top 10 sources of FDI outflows, 2005-06

15. Types of FDI
FDI
By Motive
By Direction
By Entry Mode
By Target

16. Types of FDI
By Direction
Inward FDI
Outward FDI

17. Types of FDI
By Target
Horizontal FDI
Vertical FDI

18. Types of FDI Horizontal FDI: Vertical FDI:
Investment in the same industry abroad as a firm operates in at home
Vertical FDI:
Backward Vertical FDI: investment in an industry abroad that provides inputs for the firm’s domestic production processes eg: oil refining, Royal Dutch/shell, British petroleum etc.)
Forward Vertical FDI: investment in which an industry abroad sells the outputs of the firm’s domestic production processes eg: Volkswagon in U.S.

19. Strategic Asset Seeking
Types of FDI
By Motive
Market Seeking
Resource Seeking
Strategic Asset Seeking
Efficiency Seeking

20. Types of FDI: By Motive
Resources seeking - looking for resources at a lower real cost.
Market seeking - secure market share and sales growth in target foreign market.
Efficiency seeking - seeks to establish efficient structure through useful factors, cultures, policies, or markets.
Strategic asset seeking - seeks to acquire assets in foreign firms that promote corporate long term objectives.

21. Mergers & Acquisitions
Types of FDI
By Entry Modes
Green-Field Ventures
Mergers & Acquisitions

22. Green-field Ventures
A Greenfield Investment is the investment in a manufacturing, office, or other physical company-related structure or group of structures in an area where no previous facilities exist.
The name comes from the idea of building a facility literally on a "green" field, such as farmland or a forest.
Green field operation:
Mostly in developing nations

23. Mergers & Acquisitions
Mergers and acquisitions:
Quicker to execute.
Foreign firms have valuable strategic assets
Believe they can increase the efficiency of the acquired firm
More prevalent in developed nations

24. FDI when and why? Transportation costs are high
Market Imperfections (Internalization Theory)
Impediments to the free flow of products between nations
Impediments to the sale of know-how
Follow the lead of a competitor - strategic rivalry
Product Life Cycle - however, does not explain when it is profitable to invest abroad
Location specific advantages (natural resources)

25. Pattern of FDI Explanations
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

26. Pattern of FDI Explanations
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

27. Pattern of FDI Explanations
Eclectic Paradigm of FDI (Dunning)
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)

28. Pattern of FDI Explanations
Eclectic Paradigm of FDI (Dunning)
Internalization advantage: transaction costs of an arms-length relationship --licensing, exports-- higher than managing the activity within the MNC’s boundaries

29. Why FDI? High transportation costs, trade barriers
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

30. Decision framework Low High FDI Yes No Export
How high are transportation costs and tariffs?
Is know-how amenable to licensing?
Is tight control over foreign operation required?
Can know-how be protected by licensing contract?
Then license
Export No
Yes
Low
FDI
High

31. Factors affecting investment decisions
Costs
Barriers
Control
Incentives like tax concessions, subsidies etc
Location advantages
Essential Criteria
Access to skilled and educated workforce
Proximity to world class research institutions
Quality of life
Access to venture capital

32. Factors affecting investment decisions
Important Criteria
Reasonable costs of doing business
Established technology presence
Available bandwidth and adequate infrastructure
Favorable business climate and regulatory environment
Desirable Criteria
Presence of suppliers and partners
Availability of community incentives

33. Political Ideology and FDI
Radical
View
Pragmatic
Nationalism
Free
Market

34. The Radical View
Marxist view: MNE’s exploit less-developed host countries
Extract profits
Give nothing of value in exchange
Instrument of domination, not development
Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology

35. The Radical View By the end of the 1980s radical view was in retreat
Collapse of communism
Bad economic performance of countries that embraced the radical view
Strong economic performance of some countries that embraced capitalism rather than the radical view

36. The Free Market View
Adam Smith, Ricardo: international production should be distributed per national comparative advantage
Nations specialize in goods and services that they can produce most efficiently
Resource transfers benefit and strengthen the host country
Pro-investment changes in laws and growth of bilateral agreements attest to strength of free market view
But all countries impose some restrictions on FDI

37. Pragmatic Nationalism
FDI has benefits and costs
Allow FDI if benefits outweigh costs
Block FDI that harms indigenous industry
Encourage FDI that is in national interest
Tax breaks
Subsidies
But who can predict which FDI is in national interest?
Regulations open opportunity for favoritism

38. Pragmatic Nationalism
Many of the most successful developing countries – past and present – followed a pragmatic nationalistic stance
Japan
South Korea
China
Economists note that Hong Kong, which followed the free market approach, was even more successful

39. The Benefits of FDI to Host countries
Resource transfer effects
Capital
Technology
Management
Employment effects
Effect on competition & economic growth

40. The Benefits of FDI to Host countries
Balance of payment effects
Initial capital inflows
Import substitution
Export of goods & services to other countries
In a free market view
Many economists argue that the benefits of FDI so outweigh the costs associated with pragmatic nationalism that it is misguided
The best policy would be for countries to forgo all intervention in an MNE’s investment decisions

41. Costs of FDI to the Host Country
Adverse effects on competition
Adverse effects on balance of payment
Outflow of earnings from foreign subsidiary to its parent company
Imports of raw material results into adverse effect on current account
Adverse effect on national sovereignty and Autonomy

42. Benefits of FDI to Home country
Positive effect on Balance of payment due to inward flow of foreign earnings & demand of home-country exports of capital-equipments
Employment effects due to demand of home country products
MNE’s learn valuable skills from foreign markets that can be transferred back to the home country

43. Costs of FDI to Home countries
Adverse effect on BOP account:
Adverse effect on capital account due to outflow of capital
Adverse effect on current account due to imports from low production locations in foreign countries
Adverse effect on current account due to export substitution
Reduced home country employment

44. Government Policy and FDI
Home country
Outward FDI encouragement
Risk reduction policies (financing, insurance, tax incentives)
Outward FDI restrictions
National security, BOP

45. Government Policy and FDI
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

46. International institutions & the liberalization of FDI
WTO (world trade organization)
OECD (Organization for economic cooperation & development)