1. Foreign Direct Investment
Chapter 7

2. Extra credit opportunity
Presentations on
a country or
a region (even a town/city in U.S.)
some other subject in global business
An especially good chance to discuss your home or your ancestors’ home

3. Length –
6 to 10 minutes (individual)
Up to 18 minutes (group)

4. A country presentation can describe
The economic environment
How do people live?
What is GNI per capita include both
unadjusted and
PPP-adjusted GNI,
compare to US
How does GNI per capita level affect life?

5. The political environment
How is the country/region governed?

6. Something of the cultural environment
You can’t summarize the culture; just say one or two things that strike you as important
The country or region’s role in global business
What does the country or region produce?
How important is it to people elsewhere?
Can you tell what is likely to happen in the future?

8. What is foreign direct investment?
An indirect investment is one where the investor does not gain control of the entity he or she invests in
I can buy stock in Toyota, but Toyota’s management won’t pay much attention to my opinions
A direct investment is one where the investing company creates a new business or gains control
When BP bought the whole of Amoco (a U.S. oil company), it took control of the firm

9. Taking control of the business your firm will work with may:
decrease operating costs
because it results in better coordination
increase rate of technology transfer
because businesses are willing to transfer tech to units they control
FDIs around here – Hitachi, Fujitsu, Sony from Japan, BP from Britain, Volkswagen owns its own dealers.

10. You can enter foreign markets without control by…
Exporting – selling your goods overseas without setting up a unit abroad that you control
Licensing – selling others the permission to use your knowhow
Franchising – where you provide a complete package to allow others to set up a business like yours – is a kind of licensing

12. How companies make foreign direct investments
Acquisition: buying an existing company
Easy to execute
Gain brand identification and goodwill
Best if your company is attempting to acquire knowledge
Building a new unit from scratch (‘Greenfield’ investment):
hire or buy local resources
construct or buy buildings
build own labor force
Foreign personnel may be difficult to hire
You control the results
Proctor & Gamble
When Sony set up a network to sell its TVs in the US, it set up a company and hired people here.

13. The Investor’s Advantage
Foreign direct investment is correlated with profitability.
Companies that do more foreign direct investment are, on average, more profitable
Why?
Create supremacy over other companies in countries of interest (monopoly)
Sell more efficiently
Get to know markets, resource sources better
Foreign currency may have a high buying power
May be able to borrow capital at a lower interest rate than companies from other countries
8-12

14. Economists generally favor free flows of foreign direct investment
They believe freedom for FDI allows business know-how to go where it will be most useful
Just as free trade allows people to use skills and resources most efficiently
We haven’t seen the dramatic problems from FDI that we’ve seen from the global capital market
Skip to ‘the free market view’

15. Trends in FDI Foreign direct investment increased in the last 20 years
In spite of decline of trade barriers, FDI grew even more rapidly than world trade because
Businesses feared protectionist pressures
FDI is seen a a way of circumventing trade barriers
Dramatic political and economic changes in many parts of the world encouraged investment
Globalization of the world economy created firms who see the entire world as their market

16. BUT – The FDI Slump
Between 2000 and 2004 the value of FDI declined almost 50% from $1.2 trillion to about $620 billion
The slowdown in FDI flows was most pronounced in developed nations
Then FDI increased dramatically
And slowed radically in

17. Figure 7.1: FDI Outflows 1982-2006 ($ billions)
Trends In FDI
Figure 7.1: FDI Outflows ($ billions)

18. The Direction of FDI
Historically, most FDI was directed at the developed nations
advanced countries invested in other markets
The US has been the favorite target for FDI inflows
While developed nations still account for the largest share of FDI inflows, FDI into developing nations has increased
Most recent inflows into developing nations have been targeted at the emerging economies of South, East, and Southeast Asia
Flows to Africa are growing, especially from China

19. Foreign Direct Investment in the World Economy
The flow of FDI refers to the amount of FDI undertaken over a given time period
The stock of FDI refers to the total accumulated value of foreign owned assts at a given time

20. Figure 7.3: FDI Inflows by Region ($ billion), 1995-2006
The Direction Of FDI
Figure 7.3: FDI Inflows by Region ($ billion),

21. The Direction Of FDI Figure 7.4: Inward FDI as a % of
Gross Fixed Capital Formation
This Figure suggests that FDI has become increasingly important as a source of investment in the world’s economies.

22. ‘Gross fixed capital formation’ is the total amount of investment in factories, stores, office buildings, and the like

23. The Source of FDI
Since World War II, the United States has been the largest source country for FDI, a position it retained during the late 1990s and early 2000s (see Figure 7.4). Other important source countries include the United Kingdom, France, Germany, the Netherlands, and Japan. Collectively, these six countries accounted for 60 percent of all FDI outflows for 1998–2003 and 63 percent of the total global stock of FDI in As might be expected, these countries also predominate in rankings of the world’s largest multinationals.
Figure 7.4, p. 244

24. The Shift to Services
A shift to services is being driven by four factors
In many developed economies, services make up growing portions of GNI
Many services cannot be traded internationally
Many countries have liberalized their regimes governing FDI in services
The rise of Internet-based global telecommunications networks has allowed some service enterprises to relocate some of their value creation activities to different nations to take advantage of favorable factor costs
In the past two decades, the sector composition of FDI has shifted sharply away from extractive industries and manufacturing and toward services. In 1990, some 47 percent of outward FDI stock was in service industries; by 2003 this figure had increased to 67 percent. Similar trends can be seen in the composition of cross-border mergers and acquisitions, in which services are playing a much larger role.

26. Should a nation always accept foreign investment?
19th Century political economists showed countries gain hugely from trade, but the case for allowing free foreign direct investment is not as strong
Foreign firms bring technology and knowhow to a country
But they can also take over positions in the local economy where local firms could
learn new technology,
earn profits they would keep at home, and
create more jobs than a foreign firm

27. The Free Market View
Nations specialize in goods and services that they can produce most efficiently
Resource transfers benefit and strengthen the host country. It
gains investments
gets new jobs
substitutes for imports
gets smart new competition in the domestic economy
Recent changes in laws and growth of bilateral agreements attest to strength of free market view

28. Pragmatic Nationalism
FDI has benefits and costs
Allow FDI if benefits outweigh costs
Block FDI that ‘harms indigenous industry’
Court FDI that ‘is in national interest’
Tax breaks
Subsidies

29. Many of the most successful developing countries – past and present – followed a pragmatic nationalistic stance
Japan
South Korea
China
Economists note that Hong Kong, which followed the free market approach, was even more successful

30. The richest countries all practice a basically free market approach
They have an association, the Organization for Economic Cooperation and Development that requires members to open their markets to foreign direct investment

32. Business Decision Making Grid for foreign direct investment
Figure 7.6, p. 256

34. Slides below here were not presented in class and are not required

35. Political Ideology and FDI
Radical
View
Pragmatic
Nationalism
Free
Market
Historically, ideology toward FDI has ranged from a dogmatic radical stance that is hostile to all FDI at one extreme to an adherence to the noninterventionist principle of free market economics at the other. Between these two extremes is an approach that might be called pragmatic nationalism.

36. The Radical View
Marxist view: MNE’s exploit less-developed host countries
Extract profits
Give nothing of value in exchange
Instrument of domination, not development
Keep less-developed countries relatively backward and dependent on capitalist nations for investment, jobs, and technology

37. The Radical View By the end of the 1980s radical view was in retreat
Collapse of communism
Bad economic performance of countries that embraced the radical view
Strong economic performance of some countries who embraced capitalism rather than the radical view

39. Costs of FDI to the Home Country
Can drive out local competitors or prevent their development
Profits brought home ‘hurt’ (debit) a host’s capital account
Parts imported for assembly hurt trade balance
Can affect sovereignty and national defense
International trade theory tells us that home-country concerns about the negative economic effects of offshore production may be misplaced. The term offshore production refers to FDI undertaken to serve the home market. Far from reducing home-country employment, such FDI may actually stimulate economic growth (and hence employment) in the home country by freeing home-country resources to concentrate on activities where the home country has a comparative advantage. In addition, home-country consumers benefit if the price of the particular product falls as a result of the FDI. Also, if a company were prohibited from making such investments on the grounds of negative employment effects while its international competitors reaped the benefits of low-cost production locations, it would undoubtedly lose market share to its international competitors. Under such a scenario, the adverse long-run economic effects for a country would probably outweigh the relatively minor balance-of-payments and employment effects associated with offshore production.

43. The Benefits of FDI to Host Countries
Four main benefits of FDI for a host country
Resource-transfer effect
Employment effect
Balance-of-Payments effect
Effect on competition and economic growth
In a free market view
Many economists argue that the benefits of FDI so outweigh the costs associated with pragmatic nationalism that it is misguided
The best policy would be for countries to forgo all intervention in an MNE’s investment decisions

45. “Horizontal” FDI Horizontal Direct Investment
FDI in the same industry abroad as company operates at home
FDI is expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise
FDI is risky because of the problems associated with doing business in another culture where the rules of the game may be different
Relative to firms native to a culture, a firm in a foreign culture has a greater probability of making costly mistakes due to ignorance. When a firm exports, it need not bear the costs of FDI, and the risks associated with selling abroad can be reduced by using a native sales agent. Similarly, when a firm licenses its know-how, it need not bear the costs or risks of FDI. So why do so many firms apparently prefer FDI over either exporting or licensing?

46. “Horizontal” FDI – When
Transportation costs for a product are high
Market Imperfections (Internalization Theory)
Impediments to the free flow of products between nations
Impediments to the sale of know-how
Follow the lead of a competitor - strategic rivalry
Product Life Cycle - however, does not explain when it is profitable to invest abroad
Location specific advantages (natural resources)

50. Info on slides below here is not required

51. Vertical FDI Vertical FDI takes two forms
Backward vertical FDI is an investment in an industry abroad that provides inputs for a firm’s domestic production processes
Forward vertical FDI occurs when an industry abroad sells the outputs of a firm’s domestic production processes, this is less common than backward vertical FDI

52. Strategic Behavior
One explanation for firm’s choice of vertical FDI is that by using vertical backward integration, a firm can gain control over the source of raw materials
This would allow the firm to raise entry barriers and shut new competitors out of an industry
Another explanation of vertical FDI is that firms use this strategy to circumvent the barriers established by firms already doing business in a country

53. Market Imperfections
The market imperfections approach offers two explanations for vertical FDI
There are impediments to the sale of know-how through the market mechanism
Investments in specialized assets expose the investing firm to hazards that can be reduced only through vertical FDI

54. Gross Capital Fixed Formation
Inward FDI as a Percent of Gross Fixed Capital Formation, 1992–2003 Note: 1992–1997 figures are annual averages Sources: Compiled by the author from data in United Nations, World Investment Report, 2004 (New York and Geneva: United Nations, 2004).
Figure 7.3, p. 244

55. Market Imperfections
Market imperfections are factors that inhibit markets from working perfectly
In the international business literature, the marketing imperfection approach to FDI is typically referred to as internalization theory
With regard to horizontal FDI, market imperfections arise in two circumstances:
When there are impediments to the free flow of products between nations which decrease the profitability of exporting relative to FDI and licensing
When there are impediments to the sale of know-how which increase the profitability of FDI relative to licensing