Session 10: Foreign Direct Investment (FDI)

International Business

Instructor:
Carlos Gonzlez, PhD
Foreign Direct Investment (FDI)

Foreign direct investment

FDI occurs when a firm invests directly in facilities to produce or market a product in a
foreign country. The firm then becomes a Multinational Enterprise (MNE).
Greenfield investment: Establishment of a new operation in a foreign country.
Mergers & acquisitions (minority, majority or full stake)
Foreign Direct Investment (FDI)

Foreign direct investment

Outflows of FDI: The flow of FDI out of a country.

Inflows of FDI: The flow of FDI into a country

Inflow FDI
FDI Drivers:
A way of circumventing future trade barriers
Political and economic changes
Outflow FDI Shift toward democratic political institutions
and free market economies
Globalization of the world economy
Foreign Direct Investment (FDI)

Foreign direct investment

Top FDI recipients

Foreign Direct Investment (FDI)

Foreign direct investment

To acquire or not to acquire? Benefits of acquisitions:

Quicker to execute than greenfield investments.
If you dont acquire the firm, one of your competitors will.
Acquired firms have valuable strategic assets: brand loyalty, customer
relationships, trademarks or patents, distribution systems, production systems, etc.
Easier and less risky to buy than to build from scratch.
Firms believe that they can increase the efficiency of the acquired unit (CEMEX
example)
Foreign Direct Investment (FDI)

Why firms engage in FDI at all?

Why firms internationalize when they could export or license their products?
Exporting: Producing goods and home and then shipping them to another country.
Licensing: Granting a foreign entity the right to produce and sell the firms product
in return for a royalty fee on every unit sold.
FDI is riskier than exporting and licensing (liability of foreigners), so why firms do it?
Foreign Direct Investment (FDI)

Why firms engage in FDI at all? -> Because of market failures

Problems with exports:

Transportation costs (low value-to-weight ratio, such as cement)
Import tariffs and quotas
Problems with licensing:
Technological leakage
No control over business activities in the foreign country
Impossible to license intangibles, such as management and marketing
knowledge (e.g., the Toyota way)
Foreign Direct Investment (FDI)

Internalization theory

The main argument behind preeminent internationalization theories, such as

transaction cost/internalization theory (Buckley & Casson, 1976; Hennart, 1977, 1982;
Rugman, 1981) is that multinational firms are in possession of FSAs that can potentially
be exploited abroad.
However, exploiting these FSAs in foreign countries is sometimes best done internally
because of the existence of market failures or high transaction costs in host countries.
Thus, internationalization arises as a response to the firms impossibility to exploit its
FSAs using non-hierarchical modes of organization, such as markets.

Country A Country B

Market failures or high transaction costs

Firm with FSAs Impossible to export or license
Direct investment is best possible action
Foreign Direct Investment (FDI)

Internalization theory

Country A Country B

Would you do business with him or would you do it yourself?

If you do it yourself you are internalizing the transaction.
Foreign Direct Investment (FDI)

Oligopolistic reaction (Knickerbocker, 1973)

FDI flows are a reflection of strategic rivalry between firms in the global marketplace.
Firms based in oligopolistic industries tend to imitate each others FDI.
Firms effectively engage in multipoint competition
Foreign Direct Investment (FDI)

The Eclectic Paradigm (Dunning)

(OLI-Model or OLI-Framework)
What type of advantages do I have if I engage/or not in FDI? These work as incentives for
FDI.

Ownership advantages: Set of Firm Specific Advantages (trademark, production

technique, entrepreneurial skills, returns to scale.
Location advantages: Advantages that arise from utilizing resource endowments or
assets that are tied to a particular foreign location (e.g., Silicon Valley).
Internalization advantages: Advantages by own production rather than producing
through a partnership arrangement such as licensing or a joint venture.

Ownership advantages: The greater, the more likely

that the firm will engage in FDI.
Location advantages: The more immobile the
foreign resources, the more the firm will need to
engage in FDI to get them.
Internalization: The greater the net benefits of
internalizing production, the more likely a firm will
engage in FDI.
Foreign Direct Investment (FDI)

Political ideology and FDI

The Radical View: Based on Marx work. The MNE is an instrument of imperialist
domination.
MNEs as a tool for exploiting host countries to the exclusive benefit of their
capitalist-imperialist home countries.
MNEs keep less developed countries of the world relatively backward and
dependent on advanced capitalist nations for investment, jobs, and technology.
-> Therefore, NO country should ever permit foreign corporations to undertake
FDI.
The view is in retreat almost everywhere.

The Free Market View: Based on Smith and Ricardo.

International production should be distributed among countries according to the
theory of comparative advantage.
The MNE is an instrument for dispersing the production of goods and services to
the most efficient locations around the globe.
Foreign Direct Investment (FDI)

Political ideology and FDI

Pragmatic nationalism:
FDI has both benefits and costs.
FDI can bring capital, skills, technology and jobs, but at a cost.
When a foreign company rather than a domestic one produces products, the
profits go abroad.
Maximize the national benefits and minimize the national cost.
Best example: Japan. Only let firms with technological know-how into the country.
Foreign Direct Investment (FDI)

Political ideology and FDI

Host-country benefits of FDI

Resource-transfer effects: Access to capital, technology, and management
resources.
Employment effects: Job creation that wouldnt otherwise happen
Balance-of-payment effects: FDI can be a substitute for imports of goods and
services. Exports also increase if the MNE subsidiary exports its output.
Host-country costs of FDI
Adverse effects on competition: MNE subsidiaries might have greater economic
power and drive smaller firms out of the market (only to then raise prices)
Adverse effect on the balance of payments: Repatriation of earnings. The
subsidiary might need to import a high number of inputs.
National sovereignty and autonomy: FDI might be accompanied by loss of
economic independence.
Foreign Direct Investment (FDI)

Political ideology and FDI

Home-country benefits of FDI

Balance of payments benefit from repatriation of earnings and exports to
subsidiaries
Employment effects (demand for home-country expats)
Learning effects (MNE learns valuable skills, location advantages, remember?)
Host-country costs of FDI
Balance of payments may suffer from initial capital outflow, increased imports
from the foreign country, and less original exports.
Employment effects: FDI is seen a s substitute for domestic production.