Foreign Direct Investment 7 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

7 - 2 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Chapter Objectives Describe worldwide patterns of foreign direct investment (FDI) and reasons for these patterns Describe each of the theories that attempt to explain why foreign direct investment occurs Discuss the important management issues in the foreign direct investment decision Explain why governments intervene in the free flow of foreign direct investment Discuss the policy instruments that governments use to promote and restrict foreign direct investment

International Investing Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter Foreign Portfolio Investments (FPI) Foreign Portfolio Investments (FPI) Foreign Direct Investments (FDI) Foreign Direct Investments (FDI)

7 - 4 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Foreign Direct Investment (FDI)  Purchase of physical assets or significant amount of ownership of a company in another country to gain some measure of management control  By contrast, portfolio investment does not involve obtaining a degree of control in a company

7 - 5 Copyright © 2014 Pearson Education, Inc. Yearly FDI Inflows Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

7 - 6 Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Reasons for FDI Growth Increasing globalization International mergers and acquisitions

7 - 7 Copyright © 2014 Pearson Education, Inc. Value of Cross-Border M&As Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

7 - 8 Copyright © 2014 Pearson Education, Inc. Worldwide FDI Flows Updated World FDI inflows  Developed (49%), developing (45%)  European Union: 28% of world FDI Developing nations  China and India attract most FDI  All of Africa: 2.8% of world FDI 82,000 multinationals with 810,000 affiliates

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter Outward and Inward U.S. FDI (in billions of USD)

Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall Chapter Stock of FDI for the United States, end of 2010 (billions of dollars) CategoriesTotal FDI in the United States$ FDI from the United States$ Foreign Direct Investment and the United States

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Discussion Question What is the difference between foreign direct investment and portfolio investment?

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Answer to Discussion Question Foreign direct investment is the purchase of physical assets or a significant amount of the ownership of a company in another country to gain a measure of management control. A portfolio investment is an investment that does not involve obtaining a degree of control in a company.

Theories of Foreign Direct Investment International Product Life Cycle Market Imperfections Theory Eclectic Theory Market Power Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall International Product Life Cycle A company begins by exporting its product and later undertakes foreign direct investment as a product moves through its life cycle Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5 th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p. 85.

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Market Imperfections (Internalization)  Trade barriers (tariffs, quotas, local content requirements, bureaucracy, etc.)  Unique advantage ( special knowledge) A company undertakes FDI when the costs of negotiating, monitoring and enforcing a contract are high or in the presence of:

Internalization Theory Copyright © 2013 Pearson Education, Inc. publihing as Prentice Hall Chapter 6 - Internalize Internationalize Low High Low Transaction Costs

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Eclectic Theory A firm undertakes FDI when location, ownership, and internalization advantages combine to make a location appealing Location advantage (optimal location) Ownership advantage (special asset) Internalization advantage (efficiency)

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Market Power A firm undertakes FDI to establish a dominant presence in an industry Vertical integration Extends company’s activities into stages of production that provide its inputs (backward integration) or absorb its out- puts (forward integration) Market power = Greater profits

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Discussion Question The eclectic theory says that firms undertake FDI when location, ownership, and __________ advantages combine to make a location appealing for investment. a. Internalization b. First-mover c. Life-cycle

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Answer to Discussion Question The eclectic theory says that firms undertake FDI when location, ownership, and __________ advantages combine to make a location appealing for investment. a. Internalization b. First-mover c. Life-cycle

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Management Issues I Control Purchase-or-build

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Management Issues II Production costs Customer knowledge

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Management Issues III Following rivals Following clients

Government Intervention in FDI Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Host Intervention in FDI Control Balance of Payments Control Balance of Payments FDI may generate exports Initial FDI boosts economy FDI may decrease imports

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Balance of Payments Capital accountCurrent account National accounting system that records all payments to entities in other countries and all receipts coming into the nation The import and export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country The purchase or sale of assets (including assets such as property and shares of common stock in a company)

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Host Intervention in FDI Obtain resources and benefits + Obtain resources and benefits + Access technology Access management skills Create employment

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Home Country Intervention in FDI Encouraging + Improves competitiveness + Offshore ‘sunset’ industries Discouraging – Remove national resources – Eliminate export markets – Eliminate domestic jobs

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Host Promotion Methods Financial incentives ■ Low or waived taxes ■ Low-interest loans Infrastructure benefits ■ Better seaports, roads, and telecom networks

Government Policy Instruments and FDI Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Host Restriction Methods Ownership restrictions ■ Prohibit investment in industries or businesses Performance demands ■ Local content requirements ■ Export targets ■ Technology transfers

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Home Promotion Methods Insurance on assets abroad Loans and loan guarantees Tax breaks on profits earned abroad Special tax treaties Persuade other nations to accept FDI

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Home Restriction Methods Higher taxes on foreign income Sanctions that prohibit investing

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Discussion Question A host government may encourage an initial FDI because the inflow can __________ its balance- of-payments position. a. Level b. Lower c. Boost

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Answer to Discussion Question A host government may encourage an initial FDI because the inflow can __________ its balance- of-payments position. a. Level b. Lower c. Boost

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