Slide global business today chap006 foreign direct investment

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights CHAPTER Foreign Direct Investment McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Key Issues • Why is FDI increasing? • Why firms choose FDI over exporting or licensing to enter a foreign market? • Why are certain locations attractive for FDI? • How does political ideology influence government policy over FDI? • From a host or source country perspective, what are FDI’s costs and benefits? • How can governments restrict/encourage FDI? McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-1 Foreign Direct Investment • Foreign direct investment (FDI) happens when a firm invests directly in facilities in a foreign country • A firm that engages in FDI becomes a multinational enterprise (MNE) – Multinational = “more than one country” • Factors which influence FDI are related to factors that stimulate trade across national borders McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-2 Foreign Direct Investment • Involves ownership of entity abroad for – – – – production Marketing/service R&D Raw materials or other resource access • Parent has direct managerial control – The degree of direct managerial control depends on the extent of ownership of the foreign entity and on other contractual terms of the FDI – No managerial involvement = portfolio investment McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-3 FDI Growth in the World Economy • FDI Outflow of $25 billion in 1975 increased to $1.3 trillion in 2000 • FDI flow accelerated more than world trade (x and x 1.8 respectively) • FDI Flow from all countries increased 1000%, trade 91%, world output 27% from 1984 to 1998 • FDI Stock increased to $3.5 trillion by 1997 • 63,000 parent firms with 690,000 foreign affiliates produced $14 trillion sales, almost twice global exports • FDI growing faster than world trade – Political risk issues – Economic reason issues – Globalization McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-4 Direction and Source of FDI • Historically, FDI flow was to developed countries from other developed countries – Much of this to the US • Since 1985 there has been an increase of FDI towards developing countries – Much to the emerging Asian and Latin America economies – Africa lagging • Through 1970s US led in FDI outflows – 1985-1990 Japan 1st, UK 2nd, US 3rd Effect of Ơ increase in value In 2000 the USA received 21.6% of world FDI; the EU received 48.7% McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-5 Forms of FDI • FDI forms – Purchase of existing assets • Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problems – New investment • No local entity exists or is available for sale, local financial incentives may encourage, no inherited problems, long lead time to generation of sales or other desired outcome – Participation in an international joint-venture • Shared ownership with local and/or other non-local partner McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-6 Alternative Modes of Market Entry • FDI – FDI - 100% ownership – FDI < 100% ownership, International Joint Venture • Majority, Equal Share, Minority Participation • • • • Strategic Alliances (non-equity) Franchising Licensing Exports – Direct vs Indirect McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-7 Why FDI? • 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 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-8 Pattern of FDI • Follow main competitors – Oligopolistic industries – Interdependence of the few major competitors forces immediate strategic responses • International product life-cycle (Vernon, see Ch 4) • Eclectic paradigm of FDI (John Dunning) – Combines ownership specific, location specific, and internalization specific advantages that drive FDI choice over a decision to enter through licensing or exports McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-9 Eclectic Paradigm of FDI (Dunning) • Ownership advantage: creates a monopolistic advantage which can be used to prevail in markets abroad – Unique ownership advantage protected through ownership – e.g., Brand, technology, economies of scale, management know-how • Location advantage: the FDI destination local market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) such that it is advantageous for the firm to locate its investment there (link to trade theory) • Internalization advantage: transaction costs of an armslength relationship licensing, exports higher than managing the activity within the MNE’s boundaries Dunning, John H. (1980). “Towards an eclectic theory of international production:  Some empirical tests.” Journal of International Business Studies 11(2): 9­31 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-10 Government Policy and FDI • The radical view: inbound FDI harmful; MNEs – – – – Are an instrument of imperialist domination Exploit host to the advantage of home country Extract profits from host country; give nothing back Keep LDCs backward/dependent for investment, technology and jobs • The free market view: FDI should be encouraged – Adam Smith, Ricardo, et al: international production should be distributed according to comparative advantage – The MNE increases the world economy efficiency because it brings to bear unique ownership advantages on the local economy’s comparative advantages McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-11 Host Country Effects of FDI • Benefits – Resource -transfer – Employment – Balance-of-payment (BOP) • Import substitution • Source of export increase • Costs – Adverse effects on the BOP • Capital inflow followed by capital outflow + profits • Production input importation – Threat to national sovereignty and autonomy • Loss of economic independence McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-12 Home Country Effects of FDI • Benefits – BOP current account adversely affected by inward flow of foreign earnings – Positive employment effect from increased exports of raw materials / assemblies to the overseas subsidiary – Repatriation of skills and know-how • Costs – BOP trade position is negatively affected (lower finished goods exports) – Loss of employment to overseas market McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-13 Government Policy and FDI • Home country – Outward FDI encouragement • Risk reduction policies (financing, insurance, tax incentives) – Outward FDI restrictions • National security, BOP • 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 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Slide 6-14 Decision Framework for FDI No Are transportation costs  high? Yes No Is know­how easy to  license? Yes Tight control over  foreign ops required? No Is know­how valuable and  is protection possible? No Export Yes FDI Yes FDI Yes FDI No McGraw-Hill/Irwin Import  Barriers? License © 2004 The McGraw-Hill Companies, Inc., All Rights ... McGraw-Hill Companies, Inc., All Rights Slide 6-1 Foreign Direct Investment • Foreign direct investment (FDI) happens when a firm invests directly in facilities in a foreign country • A firm that engages... All Rights Slide 6-2 Foreign Direct Investment • Involves ownership of entity abroad for – – – – production Marketing/service R&D Raw materials or other resource access • Parent has direct managerial...CHAPTER Foreign Direct Investment McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Key Issues