Foreign Direct Investment Chapter 7

Definition of FDI FDI is an investment involving a long-term relationship and reflecting a lasting interest and control by a resident entity in one economy, in an enterprise, resident in an economy, other than that of the investor. FDI occurs when a firm invests directly in facilities to produce and/or market a foreign product.

Foreign Direct Investment Wholly–owned subsidiary Adopted when needing substantial control Through Greenfield- the establishment of a wholly new operation in a foreign country acquisitions/mergers- acquiring or merging with a with an existing firm in a foreign country. Joint venture Jointly owned by two or more independent firm Preferred for an initial entry into a foreign market; often the only form of FDI in certain markets

FDI in Bangladesh Source : WIR report June 2014, UNCTAD, BOI By registering the growth, Bangladesh secured the second position among eight Saarc nations, outpacing Pakistan in attracting foreign investors. India continued to be the leader in luring foreign investors. Of the $1.6 billion FDI that Bangladesh received last year, $541 million came as equity (direct investment in Bangladesh), $361 million as intra- company loans (debt transactions between parent enterprises and affiliates) and $697 million were reinvested earnings (investors' share of profits not distributed as profits). Inflows of foreign direct investment into Bangladesh rose 24 percent year-on-year to $1.6 billion in 2013 although the country witnessed serious political unrest and an anti- business climate during the period.

FDI in Bangladesh Source: BOI Bangladesh

Foreign Direct Investment (FDI) 1) Horizontal Foreign Direct Investment- Is the FDI in the same industry in which a firm operates at home. Telecommunication companies 2) Vertical Foreign Direct Investment-The FDI in an industry that provide inputs for a firms domestic operations, or it may be FDI in an industry abroad that sells the outputs of a firm’s domestic operations. GAP International sourcing, IKEA

FDI In The World Economy  Stock of FDI- The total accumulated value of foreign- owned assets at a given time. The flow of FDI refers to the amount of FDI undertaken over a given time period (normally a year.) Outflows of FDI Inflow of FDI

Trends in FDI in the World Economy The Direction of FDI The BRICS countries continue to be important outward investors. The sharp decline of FDI flows from developed countries, FDI flows from developing economies rose slightly in 2012, amounting to $426 billion. Among developing regions, FDI outflows from Africa nearly tripled, flows from Asia remained unchanged from their 2011 level, and those from Latin America and the Caribbean declined slightly. Asian countries remained the largest source of FDI in the developing world, accounting for almost three-quarters of the group’s total. Global foreign direct investment (FDI) inflows fell by 18% from $1.65 trillion in 2011 to $1.35 trillion in 2012, Global FDI outflows fell by 17% to $1.4 trillion, down from $1.7 trillion in 2011.

Merger and acquisition are quicker to execute. Acquiring ready–made international network of subsidiaries owned by acquire. Existing assets of acquire: brand name, local knowledge, distribution network, customer relationships etc. (also reducing risk) Perhaps low price if deinvestment Potential for efficiency gains by transferring capital, technology or management skills. The Form of FDI: Acquisitions versus Greenfield

Why Foreign Direct Investment Exporting : involves producing goods at home and then shipping them to the receiving country for sale. Transportation costs Trade barriers : tariffs and quotas Licensing : involves granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit sold. Giving away valuable technological knowhow Does not give tight control over manufacturing, marketing and strategy Other capabilities to manufacture the products (e.g. management, marketing and manufacturing capabilities) Foreign Direct Investment

Toyota’s Ways 1) long-term philosophy, (2) the right process will produce the right results, (3) add value to the organization by developing your people, and (4) continuously solving root problems drives organizational learning. 1) overproduction; (2) waiting, time on hand; (3) unnecessary transport or conveyance; (4) overprocessing or incorrect processing; (5) excess inventory; (6) motion; and (7) defects.

Strategic Behavior- The theory expounded by F.T. Knickerbockers explain FDI is based on the idea that FDI flows are reflection of strategic rivalry between firms in the global market place. Multipoint competitions arises when two or more enterprises encounter each other in different regional markets, national markets or industries. The idea is to ensure that the rival does not gain a commanding position in one market and then use the profit generated to there to subsidize competitive attacks in other markets.

Oligopoly- An industry composed of limited number of large firms which are highly interdependent. Players of these industries imitate each other FDI. Four music companies control 80% of the market - Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group Six major book publishers - Random House, Pearson, Hachette, HarperCollins, Simon & Schuster and Holtzbrinck Four breakfast cereal manufacturers - Kellogg, General Mills, Post and Quaker Two major producers in the beer industry - Anheuser-Busch and MillerCoors Two major providers in the healthcare insurance market - Anthem and Kaiser Permanente

Product Life cycle theory- Firms invest in foreign country when demand in that country will support local production and they do invest in low-cost location when cost pressure become intense. John Dunning’s Eclectic Paradigm Location- specific advantages- The advantages that arise from using resource endowments or assets that are tied to a particular foreign location and that a firms finds valuable to combine with its own unique assets. Externalities/ spill over:

Political Ideology and Foreign Direct Investment The Radical View The Free Market View Pragmatic Nationalism Shifting Ideology

Government policy instruments and FDI Home country policies Encouraging outward FDI (for example, government backed insurance programs, special funds or loans to firms wishing to invest in developing countries, elimination of double taxation and home country’s political influence on host countries) Restricting Outward FDI (for example, limiting capital outflows out of concern for country’s balance of payments, manipulation of tax laws and prohibiting national firms from investing in certain countries)

Host country policies Encouraging inward FDI (for example, incentives like tax concessions, new state spending on infrastructure and low interest loans) Restricting inward FDI (for example owner restraints and performance requirements) Owner restraints (for example, foreign companies are excluded from specific fields, foreign ownership is permitted through a significant proportion of the equity has to be locally owned)

(Ownership restraints seem to based on the belief that local owners can help maximize the resource transfer and employment benefits of FDI for the host country) Performance requirements (for example, controls over the behavior of MNEs local subsidiary) (the use of local content, exports, technology transfer and local participation in top management)

Costs and Benefits of FDI for Developing Countries The transfer of technology to individual firms and technological spillover to the wider economy Increased productive efficiency due to the competition from multinational subsidiaries Improvement in the quality of the factors of production including management in other firms and not just the host firm Benefits to the balance of payments through the inflow of investment funds Increase in exports

Increases in savings and investment, hence, faster growth of output and employment. Customers may benefit from both lower prices of goods and the introduction of new or better quality goods and Gains in employee training, in the course of opening the new businesses, which contributes to human capital development in the host country Costs One possible negative effects of FDI is on the balance of payments due to an increase in the import of inputs by subsidiaries and to payments of dividends and royalties abroad FDI could also discourage the development of technical knowhow by and in local firms and to the detriment of the growth of domestic producers and the national economy Other factors on the cost side are social costs in the form of unemployment when FDI which is relatively capital intensive, causes the more labor intensive local firms to close down

Host Country Benefits/ Costs Benefits Resource Transfer Effects Employment Effects Balance of Payment Effects Effect on Competition and Economic Growth Costs Adverse Effects on Competition Adverse Effects on the Balance of Payments National Sovereignty and Autonomy

Home Country Benefits and Costs Benefits Inward flow of foreign earnings Employment effects arising from demand for home- country exports Learning valuable skills from its exposure to foreign markets Cost Initial capital outflow to finance the FDI Deficit balance of payments if the purpose of Foreign investment is to serve the home market from a low cost production location. Reduction in home country’s employment.