Foreign Direct Investment

Direct investment is the control of a company in one country by a company based in another country. Because control is difficult to define, some arbitrary minim um share of voting stock owned is used to define direct investment. Countries are concerned about who controls operations within their borders becau se they fear decisions will be made contrary to the national interest. Companies often prefer to control foreign production facilities because the tran sfer of certain assets to a noncontrolled entity might undermine their competitiv e position and they can realize economies of buying and selling with a controlle d entity. Although a direct investment abroad generally is acquired by transferring capital from one country to another, capital usually is not the only contribution made by the investor or the only means of gaining equity. The investing company may su pply technology, personnel, and markets in exchange for an interest in a foreign company. Production factors and finished goods are only partially mobile internationally. Moving either is one means of compensating for differences in factor endowments among countries. The cost and feasibility of transferring production factors rath er than finished goods internationally will determine which alternative results in cheaper costs. Although FDI may be a substitute for trade, it also may stimulate trade through sales of components, equipment, and complementary products. Foreign direct invest ment may be undertaken to expand foreign markets or to gain access to supplies o f resources or finished products. In addition, governments may encourage such inv estment for political purposes. The price of some products increases too much if they are transported internation ally; therefore foreign production often is necessary to tap foreign markets. As long as companies have excess domestic capacity, they usually try to delay es tablishing foreign production. The extent to which scale economies lower production costs influences whether pr oduction is centralized in one or a few countries or dispersed among many countr ies. Because most FDIs are undertaken for the purpose of selling the output in the co untry in which the investments are located, governmental restrictions that preve nt the effective importation of goods are a compelling force that cause companie s to establish such investments. Consumers may feel compelled to buy domestically produced goods even though thes e products are more expensive. They also may demand that products be altered to f it their needs. Both of these considerations may dictate the need for a company to establish foreign operations to serve its foreign markets. FDI sometimes has chain effects: When one company makes an investment, some of i ts suppliers follow with investments of their own, followed by investments by the ir suppliers, and so on. Within oligopolistic industries, companies often invest in a foreign country at about the same time. This sometimes occurs because they are responding to simila r market conditions and sometimes takes place because they wish to negate compet itors' advantages in that market. Vertical integration is needed to control the flow of goods from bask production to final consumption in an increasingly interdependent and complex world distrib ution system. It may result in lower operating costs and enable companies to tran sfer funds among countries. Rationalized production involves producing different components or different pro ducts in different countries to take advantage of different factor costs. The least-cost production location may shift over time, especially in relation t o stages of a product's life cycle. It also may change because of governmental i ncentives that effectively subsidize production. Countries may encourage domestically headquartered companies to invest abroad in

order to gain advantages over other countries. There are advantages and disadvantages to FDI by either acquisition or start-up. Monopolistic advantages help to explain why companies are willing to take what t hey perceive to be higher risks of operating abroad. Certain countries and curre ncies have had such advantages, which helps to explain the dominance of companies from certain countries at certain times. FDI may enable MNEs to spread certain fixed costs more than domestic companies ca n. It also may enable them to gain access to needed resources, to prevent compet itors from gaining control of needed resources, and to smooth sales and earnings on a year-to-year basis. Most FDI originates from and goes to developed countries. The fastest recent gro wth of FDI has been in the service sector.