Chapter 4 - Foreign direct investment: practice and theory. This chapter discusses the recent trends in Foreign Direct Investment (FDI) and a few theories explaining those trends. The main goals are to: Describe the importance of FDI in the world economy, and the changing geographic and sectoral patterns of FDI over time; explain the benefits and costs of FDI for host and home countries; present a number of different theories that attempt to explain the FDI rationale; outline the interlinkages between international trade and FDI.
Chapter Foreign direct investment: practice and theory Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–1 Lecture plan • Determinants of Foreign Direct Investment(FDI) • FDI concepts – FDI outflows/FDI inflows – outward & inward FDI stock – mergers and acquisitions • Sectoral distribution of FDI • Theories of FDI: global horizons; the international product cycle; internalisation Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–2 Foreign direct investment (FDI) • An investment involving management control of a resident entity in one economy (the host country), by an enterprise in another economy (the home country) • FDI involves a long-term relationship reflecting an investor’s lasting interest in a foreign entity The investor (the parent firm) and the foreign entity/asset (the ‘affiliate’— ‘subsidiary’ Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–3 Average annual growth rate,World FDI outflows, exports of goods and services, GDP, 1986–90, 1991–95, 1996–00, 2001–03, % p.a 40 30 20 FDI Outflow s 10 Exports of G & S -10 1986-90 1991-95 1996-00 2001-03 GDP -20 -30 Source: adapted from UNCTAD 2004 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–4 FDI Concepts • Flow: amount of FDI over a period of time (one year) • Stock: total accumulated value of foreign owned assets at a given point in time Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–5 Other FDI concepts • FDI flows (outflows, inflows) • FDI stock (outward, inward) • ‘Greenfield’ investment = new investment made up by setting up a new affiliate overseas • Cross border M & As (mergers and acquisitions) = acquisition of more than 10% equity share of an existing operation overseas – mergers = the combining of two or more firms – acquisition = take-over of an existing operation Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–6 M & As vs greenfield investments • • At the time of entry and in the short term M & As may involve smaller benefits or larger negative impacts from the perspective of host-country development – Financial resources not always add to stock – Less likely to transfer new technologies and skills – Does not generate employment (possible lay-offs) – Can increase concentration and lessen competition However, in the long term many differences diminish or disappear Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–7 M & As vs greenfield investments cont • UNCTAD’s World Investment Report 2000 concluded that, under normal circumstances, greenfield FDI is more useful, in terms of its developmental impact, to host countries than cross-border M & As • However, under exceptional circumstances (e.g economic crisis) cross-border M & As can play a useful role Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–8 Determinants of foreign direct investment • Trade restrictions – the ‘Trojan horse’ • Cost/profitability factors • Investment climate • Marketing factors Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–9 Trade restrictions: the ‘Trojan’ horse’) • Barriers to trade • Preference of local customers for local products Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–10 Investment climate • Government attitude toward foreign investment (e.g incentives) • Political stability • Limitations on ownership • Currency exchange regulations • Stability of foreign exchange • Tax structure Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–12 Geographic distribution of FDI outflows, 1983–2003, % of world outflows Year Developed Developing Economies (%) Economies (%) Central and Eastern Europe (%) 1983–1987 95.0 5.0 0.01 1988–1992 93.0 7.0 0.02 1998–2000 92.9 6.8 0.3 2001–2003 92.0 7.2 0.8 Source: adapted from UNCTAD’s World Investment Reports, 1995–2001 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–13 Top 10 sources of outward FDI in 2001–03, % of world total 24.3 US 13.4 UK Germ any 8.3 France 8.0 4.9 Netherlands Hong Kong 4.6 Japan 4.3 Sw itzerland 4.1 Canada Belgium /Lux 3.8 3.3 Source: adapted from UNCTAD, World Development Report 2004 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–14 Geographic distribution of FDI inflows,1983–2003,% of world inflows Year Developed Economies (%) Developing Economies (%) Central and Eastern Europe (%) 1983–1987 74.0 26.0 0.04 1988–1992 82.7 17.1 0.2 1998–2000 76.3 21.4 2.3 2001–2003 69.5 26.7 3.8 Source: adapted from UNCTAD’s World Investment Report, 1994 and 2001 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–15 Shares (%) of leading 11 economies in world inward FDI stock in 2003 U.S U.K China France Hong Kong Be lgium/Lux Ne the rlands Canada Spain Ire land Australia 6.1 5.3 4.5 4.3 4.1 3.3 2.8 2.3 2.1 8.2 18.8 % Source: adapted from UNCTAD, World Development Report 2004 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–16 Sectoral distribution of FDI inward stock, 1990, 2002 Developed Countries (%) Sector Developing Countries (%) C & Eastern Europe (%) 1990a 2002a 1990a 2002a 1990a 2002a Primary sector 10 7 … Manufacturing 41 32 46 38 … 39 Services 49 62 47 55 … 58 a or latest year available Source: adapted from UNCTAD, World Investment Report 2004 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–17 FDI benefits/costs to host countries • Benefits – capital – technology – management – employment – exports – current account (?) • Costs – adverse effects on competition – adverse effects on the balance of payments – concerns about national sovereignty Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–18 FDI benefits to home countries • Improves balance of payments • Positive employment effects – export demand can create jobs • Increased knowledge from operating in a foreign environment • Benefits the consumer through better products and lower prices Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–19 FDI costs to home countries • Negative effect on balance of payments – initial capital outflow (offset by subsequent inflows) – Multinational Enterprise (MNE) uses foreign subsidiary to sell back to home market – MNE uses foreign subsidiary as a substitute for direct exports (loss of export earnings) • Potential ‘export’ of jobs Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–20 FDI and international trade • The relationship between trade and FDI in a given product is characterised by a sequential process of internationalisation, e.g trade to FDI or FDI to trade • Subsidiaries source goods and services from parent companies and can exports from the host country • FDI is not only a source of capital but also of new technology, managerial skills and marketing networks Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–21 Exports of foreign affiliates as % of total exports in primary and secondary sectors Various years 45.1 Canada(1994) 22.3 US(1996) 21.1 Mexico(1993) 60.6 Singapore(1996) 51 Malysia(1994) 35.4 Hong Kong,China(1997) 40.9 China(1997) 10 20 30 40 50 60 70 % of total exports Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–22 Foreign direct investment theories • The global horizons theory • The international product cycle • The internalisation theory Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–23 The global horizons theory • Internal forces – influence of a high executive – need to market a new technology//product – finding use for old equipment – observed need for a larger market – mergers/acquisitions (e.g BHP–Utah International) • External forces – influence of customers – initiative of foreign government – foreign expansion of a competitor – dramatic event (e.g formation of a free-trade area) Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–24 International product cycle production Innovating country (e.g US, Japan) Exports Q u a n t i t y Imports consumption 10 11 12 13 14 Other industrial countries 15 Exports Imports 10 11 12 13 14 15 Developing countries Exports Imports New Product Maturing Product 10 11 12 13 14 15 Standardised Product Stages of Production Development 425 Time 4–25 Source: Fig 4.4 The internalisation theory • Internalisation: the extension of ownership by a firm to cover new markets,new sources of materials and new stages of the production process • Horizontal/vertical integration • MNE accomplishes an international transfer of factors,services and goods more efficiently than external markets • MNE: an institution designed to create and exploit internal markets Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4–26 ... 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4 20 FDI and international trade • The... Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4 24 International product... Ltd PPTs t/a International Trade and Investment: An Asia-Pacific Perspective 2e by Gionea Slides prepared by John Gionea 4 9 Trade restrictions: the ‘Trojan’ horse’) • Barriers to trade • Preference