1. Global Business Management (MGT380) Lecture #9: Foreign Direct Investment

2. Learning Objectives  Understand the patterns of FDI  Understand the political ideology and FDI.  Costs and benefits of FDI

3. 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

4.  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.

5.  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

6. What Is The Pattern Of FDI?  Why do firms in the same industry undertake FDI at about the same time and the same locations?  Knickerbocker : Suggests that firms follow their domestic competitors overseas. FDI flows are a reflection of strategic rivalry between firms in the global marketplace  More pertinent in Oligopolistic market. Firms A, B & C  multipoint competition -when two or more enterprises encounter each other in different regional markets, national markets, or industries  For example: Toyota and Nissan responded to investment of Honda; Electrolux did in response of G.E and Whirlpool

7.  Vernon - firms undertake FDI at particular stages in the life cycle of a product  Xerox initially build capacity in US and exported, later build its production facilities in Europe and Japan.  This theory is did well to explain  When demand of country support the production and shift production to low-cost markets when competition is high  It fails to explain  Why firm do FDI when export/license is profitable (because of economies of scale)

8.  But, why is it profitable for firms to undertake FDI rather than continuing to export from home base, or licensing a foreign firm?  According to Dunning’s eclectic paradigm- it is important to consider  location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets. Electrolux in China,  externalities - knowledge spillovers that occur when companies in the same industry locate in the same area. Firms willing to take advantage of low-cost labor/natural resources/ technology they go accordingly. Silicon Valley in CA.

9. What Are The Theoretical Approaches To FDI? How does a government’s attitude affect FDI?  You can think of ideology toward FDI as being on a continuum where at one end is the radical view that’s hostile to all FDI, and at the other end is the noninterventionist principle of free market economies. In between these two extremes is pragmatic nationalism.  Radical view (traces its roots to Marxist political and economic theory).  This perspective argues that the MNE is an instrument of imperialist domination and a means of exploiting host countries for the benefit of their capitalist-imperialist home countries.  In other words, MNE will fill all important jobs with home country citizens, and so control key technology leaving the host nation dependent on the capitalist country for investment, jobs, and technology.  Socialist and Nationalists  Since, then the radical stance has been in retreat as (i)collapse of USSR, (ii) people see that the countries that embraced capitalism rather than the radical ideology have been far more successful economically.

10.  Free market perspective which argues that international production should be distributed among countries according to the theory of comparative advantage. So, of course it traces its roots to Adam Smith and David Ricardo.  This perspective suggests that countries specialize in the production of the goods they can produce most efficiently and trade for everything else. It then follows, that FDI will actually increase the overall efficiency of the global economy.  So, if Ford moves the assembly of some of its cars to Mexico to take advantage of cheaper labor costs, Ford is not only freeing up resources in the U.S. which could then be used in activities in which the U.S. has a comparative advantage, Ford’s also transferring technology, skills, and capital to Mexico. Both countries gain!  While no country has fully adopted the pure free market stance, this ideology has been embraced by many developed and developing nations like the U.S., Hong Kong, and Chile. US airline 25%, US Television broadcast network, national security.

11.  In the middle of the continuum is pragmatic nationalism which argues that FDI has both benefits and costs.  Benefits include things like inflows of capital, technology, skills, and jobs, while costs include the repatriation of profits and negative balance of payments effects.  Pragmatic nationalism suggests that FDI should only be allowed if the benefits outweigh the costs.  We’ve seen a shift toward the free market stance in recent years, and you already know of course that along with that shift there’s been a surge in FDI. Countries compete with each other to attract FDI. Britain attracted Nissan, Toyota, Honda.  Keep in mind though, that FDI is still viewed with hostility in some countries and in some situations. IBM and Texas Instrument went Japan- High-tec  As the Management Focus in your text outlines, the U.S. recently rejected an effort by DP World to invest in U.S. ports.

12. Wal-Mart’s FDI

13. Discussion questions:  What are the competitive advantages of Wal-Mart  To what extent their strategy of FDI was successful?

14. Review questions The establishment of a wholly new operation in a foreign country is called A) an acquisition B) a merger C) a greenfield investment D) a multinational venture

15. The amount of FDI undertaken over a given time period is known as A) the flow of FDI B) the stock of FDI C) FDI outflow D) FDI inflow

16. Most FDI is direct toward a) developed countries b) emerging economies c) the United States d) China

17. Advantages that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets are a) First mover advantages b) Location advantages c) Externalities d) Proprietary advantages

18. Benefits of FDI include all of the following except a) The resource transfer effect b) The employment effect c) The balance of payments effect d) National sovereignty and autonomy

19. Summary of the lecture  Why do firms in the same industry undertake FDI at about the same time and the same locations?  Knickerbocker : Suggests that firms follow their domestic competitors overseas. FDI flows are a reflection of strategic rivalry between firms in the global marketplace; More pertinent in Oligopolistic market. For example: Toyota and Nissan responded to investment of Honda; Electrolux did in response of G.E and Whirlpool.  Vernon - firms undertake FDI at particular stages in the life cycle of a product; Xerox; This theory is did well to explain  When demand of country support the production and shift production to low-cost markets when competition is high  It fails to explain that why firm do FDI when export/license is profitable (because of economies of scale)

20.  According to Dunning’s eclectic paradigm- it is important to consider: location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets. Electrolux in China, externalities - knowledge spillovers that occur when companies in the same industry locate in the same area. Firms willing to take advantage of low-cost labor/natural resources/ technology they go accordingly. Silicon Valley in CA.  How does a government’s attitude affect FDI?  1. Radical view (traces its roots to Marxist political and economic theory). This perspective argues that the MNE is an instrument of imperialist domination and a means of exploiting host countries for the benefit of their capitalist-imperialist home countries. Socialists and Nationalists, world is changing

21.  Free market perspective which argues that international production should be distributed among countries according to the theory of comparative advantage. This perspective suggests that countries specialize in the production of the goods they can produce most efficiently and trade for everything else. It then follows, that FDI will actually increase the overall efficiency of the global economy. Not fully embraced.  In the middle of the continuum is pragmatic nationalism which argues that FDI has both benefits and costs. Benefits include things like inflows of capital, technology, skills, and jobs, while costs include the repatriation of profits and negative balance of payments effects. Pragmatic nationalism suggests that FDI should only be allowed if the benefits outweigh the costs.