FDI (Foreign direct Investment) Chapter 8

What is DFI?  Flow of capital from a country to another to establish production or service facilities used to conduct business activities  Ownership share of at least 10 or 25%  Different from (1) portfolio investment and (2) investment of earnings from FDI  Recently more rapidly growing than trade

Why FDI? (What advantages of control?)  Easiness of transfer of technology and other competitive assets (Appropriability theory tells that companies deny rivals access to vital resources.)  Cost reduction through internationalization

Trade and DFI  Substitution –Factor mobility (FDI) can be a substitute for trade (exporting), especially when there are some trade restrictions.  Complementarity –In the long run FDI can stimulate trade (exporting) of the home country because of need for components and capital equipments for subsidiaries and sales of home-made complementary products. –Actually 1/3 of the world trade is among controlled entities.

Motives for FDI  Market expansion (market seeking) –Most FDI for this reason  Resource acquisition (resource- seeking) –Increasing trend in recent years  Risk reduction  Political motives

Market Expansion (Why FDI instead of trade?)  High transportation cost  horizontal expansion  When no or low gains from scale economies  To overcome trade (tariffs, quotas) and nontrade (Nationalism) barriers  When lack of domestic capacity

Resource acquisition (Why FDI instead of trade?)  Vertical integration  cost reduction  To achieve rationalized (optimal) production  To access to essential resources  To take advantage of lower costs of resources (at the maturity or decline stages of the product life cycle)  To take advantages of incentives given by the host government.

Risk reduction  Diversification to minimize cyclical swings in sales and profits  To prevent competitors’ advantage  To follow customer firms

Two types of FDI  Acqusition (or merge) of existing frims –No startup problems –Easier financing –Readily available resources  Establishing a new firm –No carry-over problems (e.g. debts) –New facilities (more efficient capital)

FDI patterns  Who invest, where and why?  Who? –Firms of developed countries (mostly MNEs)  Where? –To developed countries –Noticeable increase in China (almost 10% of world total FDI)  Why? –Market seeking –Resource seeking