2 The Extent and Patters of

Foreign Direct Investment

BY ANIL KHADKA
Foreign Direct Investment

A PREREQUISITE TO ECONOMIC GROWTH?

 Foreign Direct Investment

Foreign investment that establishes a lasting interest in or effective

management control over an enterprise. Foreign direct investment can
include buying shares of an enterprise in another country, reinvesting
earnings of a foreign- owned enterprise in the country where it is
located, and parent firms extending loans to their foreign affiliates.
International Monetary Fund (IMF) guidelines consider an investment
to be a foreign direct investment if it accounts for at least 10 percent of
the foreign firm's voting stock of shares. However, many countries set a
higher threshold because 10 percent is often not enough to establish
effective management control of a company or demonstrate an
investor's lasting interest.

http://www.worldbank.org/depweb/ english/beyond/global/glossary. html

 Economic Growth

Quantitative change or expansion in a country's economy. Economic

growth is conventionally measured as the percentage increase in
gross domestic product (GDP) or gross national product (GNP)
during one year. Economic growth comes in two forms: an economy
can either grow "extensively" by using more resources (such as
physical, human, or natural capital) or "intensively" by using the
same amount of resources more efficiently (productively). When
economic growth is achieved by using more labor, it does not result
in per capita income growth (see Chapter 4). But when economic
growth is achieved through more productive use of all resources,
including labor, it results in higher per capita income and
improvement in people's average standard of living. Intensive
economic growth requires economic development.

http://www.worldbank.org/depweb/ english/beyond/global/glossary. html

 Trends in FDI
Flow and stock increased in the last 20 years
In spite of decline of trade barriers, FDI has
grown more rapidly than world trade because
Businesses fear protectionist pressures
FDI is seen a 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
 The Direction of FDI

Historically, most FDI has been directed at the developed

nations of the world as firms based in advanced countries
invested in other markets
The US has been the favorite target for FDI inflows

While developed nations still account for the largest share

of FDI inflows, FDI into developing nations has increased

Most recent inflows into developing nations have been targeted at

the emerging economies of South, East, and Southeast Asia
FDI Flow by Region
 Does Fact = Theory?

Gross fixed capital formation summarizes the total

amount of capital invested in factories, stores, office
buildings, etc.

SO
This makes FDI a crucial determinant factor of
increased future growth rate of an economy

RIGHT???
 Costs of FDI to Host Countries
Adverse effects on competition

Adverse effects on the balance of payments

After the initial capital inflow there is normally a subsequent
outflow of earnings
Foreign subsidiaries could import a substantial number of inputs

National sovereignty and autonomy

Some host governments worry that FDI is accompanied by some
loss of economic independence resulting in the host countrys
economy being controlled by a foreign corporation
Political Ideology and FDI

Radical Pragmatic Free

View Nationalism Market
Political Ideology & FDI
 The Radical View

Marxist view: MNEs 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
 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 countries who embraced
capitalism rather than the radical view
 The Free Market View

Nations specialize in goods and services that they

can produce most efficiently
Resource transfers benefit and strengthen the
host country
Positive changes in laws and growth of bilateral
agreements attest to strength of free market view
All countries impose some restrictions on FDI
 Trinidad and Tobago, a recipient of substantial
FDI inflows in its natural gas
http://ideas.repec.org/p/dgr/unuint/200307.html
Lou Anne A. Barclay

FDI inflows in its natural gas industry for the last decade

FDI-assisted development only occurs when governments in less-

developed economies pursue credible, selective intervention policies
 Pragmatic Nationalism

FDI has benefits and costs

Allow FDI if benefits outweigh costs
Block FDI that harms indigenous industry
Court FDI that is in national interest
Taxbreaks
Subsidies
 REGIONAL DEVELOPMENT
IMPLICATIONS OF FDI

Post Communist Eastern Europe, e.g. Czech

Automotive Components
Foreign direct investment (FDI) has been accorded a central role in the post-
communist economic transformation of Central and Eastern Europe.

Regional effects of FDI in Central Europe (Czech Republic, Hungary, Poland

and Slovakia) in the 1990s.

Defining FDIs role in regional economic transformations

Intensification of Uneven Development
Development of a Dual Economy
Failure to Develop Linkages with Local and Regional Economies
Contributionto Increased Regional Economic Instability

Petr Pavlnek
http://eur.sagepub.com/cgi/reprint/11/1/47.pdf#search=%22FDI-Economic%20Development%22
 Legal Institutions and FDI

Debate over relationship between legal institutions and

foreign investment flows
Traditional/orthodox view: legal institutions play a crucial role in
the process of market-oriented development
by protecting private rights, especially the property and contract
rights of foreign investors
By creating the legal foundations for market-oriented reform
 GOALS
: Investor experience suggests that:

A conventional program of market-oriented legal reform is NOT a

prerequisite for foreign investment

Try to Identify Why!

Legal institutions play a small, if any, role in determining the initial

decision to invest

WHY???

The form and content of useful law, as well as the significance of law
generally, seem to depends on the details of the project and the setting

What are the constants that can be identified in Success stories?

 What Is FDI?
The flow of FDI - 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 - the total accumulated value of
foreign-owned assets at a given time
 What Are The Patterns Of FDI?
Both the flow and stock of FDI have increased over
the last 30 years
Most FDI is still targeted towards developed nations
United States, Japan, and the EU
but, other destinations are emerging
South, East, and South East Asia especially
China
Latin America
What Are The Patterns Of FDI?
FDI Outflows 1982-2010 ($ billions)
What Are The Patterns Of FDI?
FDI Inflows by Region 1995-2010 ($ billion)
 What Are The Patterns Of FDI?
The growth of FDI is a result of
1. a fear of protectionism
want to circumvent trade barriers
2. political and economic changes
deregulation, privatization, fewer restrictions on FDI
3. new bilateral investment treaties
designed to facilitate investment
4. the globalization of the world economy
many companies now view the world as their market
need to be closer to their customers
 What Are The Patterns Of FDI?
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
What Are The Patterns Of FDI?
Inward FDI as a % of Gross Fixed Capital Formation 1992-2008
What Are The Patterns Of FDI?
Inward FDI as a % of Gross Fixed Capital Formation 1992-2008
 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 60% of all FDI outflows
from 1998-2010
What Is The Source Of FDI?
Cumulative FDI Outflows 1998-2010 ($ billions)
 Why Do Firms Choose Acquisition Versus
Greenfield Investments?

Most cross-border investment is in the form of

mergers and acquisitions rather than greenfield
investments
between 40-80% of all FDI inflows per annum from 1998 to
2009 were in the form of mergers and acquisitions
but in developing countries two-thirds of FDI is
greenfield investment
fewer target companies
 Why Do Firms Choose Acquisition Versus
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 Choose FDI?
Question: Why does FDI occur instead of
exporting or licensing?
1. 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
 Why Choose FDI?
2. Licensing - granting a foreign entity the right to
produce and sell the firms product in return for
a royalty fee on every unit that the foreign entity
sells
Internalization theory (aka market imperfections theory)
- compared to FDI licensing is less attractive
firm could give away valuable technological know-how
to a potential foreign competitor
does not give a firm the control over manufacturing,
marketing, and strategy in the foreign country
the firms competitive advantage may be based on its
management, marketing, and manufacturing
capabilities
 What Is The Pattern Of FDI?
Question: Why do firms in the same industry
undertake FDI at about the same time and the
same locations?
Knickerbocker - FDI flows are a reflection of
strategic rivalry between firms in the global
marketplace
multipoint competition -when two or more enterprises
encounter each other in different regional markets,
national markets, or industries
Vernon - firms undertake FDI at particular stages
in the life cycle of a product
 What Is The Pattern Of FDI?
Question: But, why is it profitable for firms to
undertake FDI rather than continuing to export
from home base, or licensing a foreign firm?
Dunnings 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
externalities - knowledge spillovers that occur when
companies in the same industry locate in the same area
 What Are The Theoretical
Approaches To FDI?
The radical view - the MNE is an instrument of
imperialist domination and a tool for exploiting
host countries to the exclusive benefit of their
capitalist-imperialist home countries
in retreat almost everywhere
The free market view - international production
should be distributed among countries according
to the theory of comparative advantage
embraced by advanced and developing nations including
the United States and Britain, but no country has adopted
it in its purest form
 What Are The Theoretical
Approaches To FDI?
Pragmatic nationalism - FDI has both benefits
(inflows of capital, technology, skills and jobs) and
costs (repatriation of profits to the home country
and a negative balance of payments effect)
FDI should be allowed only if the benefits outweigh the
costs
Recently, there has been a strong shift toward the
free market stance creating
a surge in FDI worldwide
an increase in the volume of FDI in countries with newly
liberalized regimes