1. Chapter 7 Foreign Direct Investment
By: Ms Adina Malik (ALK)

2. Learning Objectives What is FDI? What is the source of FDI?
Trends and Direction of FDI
The form of FDI
Logics supporting FDI over Exporting and Licensing
The Pattern of FDI
How FDI Benefits the Host Country and Home Country?
How is FDI Costly for the Host Country and Home Country?

3. WhaT is FDI?
Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign country
Once a firm undertakes FDI it becomes a multinational enterprise
FDI can be:
Greenfield investments - the establishment of a wholly new operation in a foreign country
Acquisitions or Mergers with existing firms in the foreign country
Acquisitions can involve:
A minority stake (10%-49%)
A majority stake (50%-99%)
A full outright stake (100%)

4. FDI 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 assets at a given time
Outflows of FDI are the flows of FDI out of a country
Inflows of FDI are the flows of FDI into a country
Gross Fixed Capital Formation-the total amount of capital invested in factories, stores, office buildings and the like.
FDI can be seen as an important source of capital investment and a determinant of the future growth rate of an economy.

5. What is the source of fdi?
Since World War II, the U.S. has been the largest source country for FDI
The United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries
Together, these countries account for 56% of all FDI outflows from , and 61% of the total global stock of FDI in 2007
Together, these countries account for 60% of all FDI outflows from
They were the most developed nations with the largest economies, post war, and naturally looked to foreign markets for economic expansion.
Cumulative FDI Outflows ($ billions)

6. The growth of FDI has been more than world trade and world output.
TREnds in fdi
The growth of FDI has been more than world trade and world output.
What are the Reasons?
Despite there has been general decline in trade barrier, companies still fear protectionist. FDI is a way to avoid future trade barrier.
E.g. Japanese companies started investing in USA to combat US trade barriers. (Cars)
Dramatic economic and political changes in developing countries and increase of free market economies in developing nations encourages FDI.
According to UN, laws governing FDI created more favourable environment for FDI.
Globalization of the world economy has encouraged companies to think world as their markets.
2. General shift towards democratic political system, free market economy; Across much of Asia, Europe and Latin America- economic growth, economic deregulation and privatization, removal of many restrictions on FDI-made these countries attractive to foreign MNCs.
3. 90% of the 2,700 changes in laws governing FDI between favorable
4. Globalization of market has created a positive impact on the volume of FDI- firms looking for significance presence in major regions of the world

7. The direction of fdi
Historically, most FDI has been directed at the developed nations of the world. E.g. USA
In 2001, China was the largest recipient of FDI among developing nations. E.g. cheap labor, tax incentive, entry into the WTO. (FDI in 2004-$60 billion; 2010-$101 billion)
After South, East and South East Asia, the next most important region in the developing world is Latin America. (FDI inflow in Latin American region in $141 billion. Historically, Mexico and Brazil were the top two recipients of inward FDI, a trend that continued in the late 2000s)
Africa attracts lowest inflow due to political unrest, armed conflict and frequent changes. ($72 billion in 2004, which slumped to $50 billion in 2010)
USA has always been the favorite location because of its large and wealthy domestic markets, its dynamic and stable economy, a favorable political environment and openness of the country to FDI.
China’s cheap labor, tax incentive and entry into the WTO have stimulated its FDI inflow. Tax incentive is reduction in tax offered as an encouragement to engage in specific activity.

9. A transition economy or transitional economy is an economy which is changing from a centrally planned economy to a market economy.

10. Sovereign Wealth Funds-The funding for a sovereign wealth fund (SWF) comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources (Source: )

11. FDI Trend of Bangladesh
FDI FLOWS
(Annual Avg)
(Annual Avg)
2008
2009
2010
Inward
386
768
1,086
700
913
Outward 6 9 29 15
Bharti Airtel acquired Abu Dhabi Group’s Warid Telecom in Bangladesh for $300 million Read more:
Figures are presented in millions of dollars (USD).
Source is

12. FDI Trend of Bangladesh
Bharti Airtel acquired Abu Dhabi Group’s Warid Telecom in Bangladesh for $300 million
In September 2004, Orascom Telecom Holdings purchased 100% of the shares of Sheba Telecom (Pvt.) Ltd. for US$ 60 million (‘Sheba’, which was a Bangladesh and Malaysia joint venture). Orascom is now known as Global Telecom Ltd.
Sanofi , GSK in Bangladesh (MNCs in Pharmaceutical sector)
HSBC, SCB, Unilever BD, BATB (MNCs in Bangladesh)
Launched in 1997, Grameenphone was the first Telenor venture in the Asian Telecom market. It is a joint venture between Telenor and Grameen Telecom Corporation, a non-profit sister concern of the internationally acclaimed microfinance organization and community development bank , Grameen Bank.

13. FDI Trend of Bangladesh
Bangladesh does not have an extensive outward FDI industry. According to UNCTAD data, FDI outflows from Bangladesh are below $0.1 billion.
Bangladesh has opened an NGO named BRAC in Afghanistan.
In Middle East, Bangladesh is seeking to increase economic ties with Saudi Arabia by investing in ceramics, pharmaceuticals and leather products.
Indonesia has recently signed a deal with Eskayef Bangladesh Ltd.
Bangladesh has invested in Sudan in the pharmaceutical industry; while in agro-processing, pharmaceuticals, science, technology and tourism sector in Egypt. In Sudan & Egypt, Bangladesh has also invested in the form of higher education.
Source: Foreign Direct Investment in South Asia: Policy, Impact, Determinants and Challenges
 By Pravakar Sahoo, Geethanjali Nataraj, Ranjan Kumar Dash

14. Sector wise fdi inflow: bangladesh

15. The form of fdi Large FDI shift towards Service Industry Reasons:
The general move of developed nations away from manufacturing toward service industry
Many service cannot be traded internationally and requires to be produced in the foreign land.
E.g. Starbucks cannot sell hot latte coffee to a consumer in Japan from Seattle store.
Many country liberalized their regimes for the service Industry.
E.g. WTO engineered to remove cross-border trade and investment in telecommunications and financial services in the late 1990s.
E.g. Brazilian telecommunication sector
Rise of Internet based global communication network.
E.g. Procter and Gamble (back-office accounting functions shifted to the Philippines)
E.g. Dell (call answering center in India)
E.g. IBM & Microsoft (software development and testing facilities in India)
E.g. After Brazil privatized its state-owned telecommunication monopoly and removed barriers to investment by foreigners in the late 1990s, FDI inflow into the industry increased.

16. Arguments against fdi over exporting or licensing
Exporting involves producing goods at home and then shipping them to the receiving country for sale. Usually done by native sales agent.
Licensing involves granting a foreign entity (the licensee) the right to produce and sell the firm’s product in return for a royalty fee on every unit sold.
Cons of FDI over exporting or licensing:
FDI is expensive- cost of establishment or acquisition
FDI is risky- cultural, political and economical situation of the host country (firm might not know the rules of the game in the host country)

17. Logics supporting fdi over exporting
Limitations of Exports
Transportation Cost:
Transportation costs increases the cost of products that have low value- to-weight ratio - FDI is preferable
E.g. Cemex (cement), soft drinks, etc.
Transportation cost will be a little percentage of production cost for products that have high value-to- weight ratio. –Export is preferable
E.g. electronic components, personal computers, medical equipment, computer software, etc.

18. Logics supporting fdi over exporting
Limitations of Exports
Trade Barriers:
FDI can also increase due to increased threats of trade barriers such as import tariffs and import quotas.
Exporting will decrease profitability.
E.g. during the 1980s and 1990s, protectionist threat by the US Congress via import quotas on Japanese cars increased FDI flow to USA by Japanese auto companies
When tariffs are imposed on imports, government increases the cost of exported goods relative to FDI and licensing. Similarly, by limiting imports through quota, government increases the attractiveness of FDI and licensing.

19. Logics supporting fdi over licensing
Limitations of Licensing
Internationalization Theory (also known as Market Imperfection Approach)
Licensing has three major drawbacks:
Licensing may result in firms giving away valuable technological know-how to potential foreign competitor.
E.g. RCA color television (USA)-Matsushita and Sony (Japan)
The firm’s lack of tight control over manufacturing, marketing and strategy in a foreign country that are required to maximize their market share and profitability.

20. Logics supporting fdi over licensing
A firm’s competitive advantage is based on its management, marketing and manufacturing capabilities, rather than its products. The problem here is that such capabilities may not be amenable to licensing.
E.g. Toyota’s competitive advantage is in its innovative production process, management know-how and organizational capabilities which are embedded in the whole organizational culture. So this culture cannot be transferred via licensing.
Toyota and Lean Production.
Lean Manufacturing or Lean Production: It’s a Japanese approach to management that focuses on cutting out waste, while ensuring quality.
Toyota’s seven wastes: transportation, inventory, motion, waiting, over-processing, over-production, defects.

21. The Pattern Of FDI
Observation suggests that firms in the same industry often undertake FDI around the same time and direct their investment activities toward certain locations.
2 theories are used to explain this pattern
Strategic Behavior (specially in oligopolistic industries)
Product Life Cycle Theory
However, these theories lack in their rationale as they fail to explain why wouldn’t a firm choose exporting or licensing over FDI.
Note: Oligopoly means when a limited number of large firms exist in a market. (e.g. an industry in which four firms control 80% of a domestic market). There is interdepence of the major players, that leads to imitative behavior.

22. The Pattern Of FDI Strategic Behavior
This theory suggests that FDI flows are a reflection of strategic rivalry between firms in the global marketplace. Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industry (imitative behavior).
E.g. Honda invested in the US and Europe. Toyota and Nissan also follow suit.
Multipoint competition: This arises when two or more enterprises encounter each other in different regional markets, national markets or industries.
E.g. Kodak & Fuji Photo Film Co.; Coke & Pepsi Co.

23. The Pattern Of FDI Product Life Cycle Theory
Vernon’s theory suggest that firm undertake FDI at a particular stage in the life cycle of a product they have pioneered.
Firms do invest in a foreign country when demand in that country will support local production and they do invest in low cost locations when cost pressure become intense.
E.g. Xerox introduced photocopier in the US, then set up production facilities in Japan (Fuji-Xerox) and UK (Rank-Xerox)

24. The Pattern Of FDI The Eclectic Paradigm
Proponent: British economist John Dunning
Location factor affects the direction or pattern of FDI.
By location-specific advantage, Dunning means advantages that arise from using resource endowments or assets that are tied to particular foreign location and that firms find valuable to combine with their own assets (technological, managerial or marketing know-how capabilities).
Examples: Oil companies investment middle eastern countries; US investment in labor intensive RMG industries based in India, China & Bangladesh; European & Japanese firms invest in the Silicon Valley region of California.

25. How does FDI benefit the host country?
There are four main benefits of inward FDI for a host country
Resource transfer effects - FDI brings capital, technology, and management resources
Employment effects - FDI can bring jobs
Balance of payments effects - FDI can help a country to achieve a current account surplus
Effects on competition and economic growth - greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers
can lead to increased productivity growth, product and process innovation, and greater economic growth

26. What Are The Costs Of FDI To The Host Country?
Inward FDI has three main costs:
Adverse effects of FDI on competition within the host nation
subsidiaries of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization
Adverse effects on the balance of payments
when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments
Perceived loss of national sovereignty and autonomy
decisions that affect the host country will be made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control

27. How Does FDI Benefit The Home Country?
The benefits of FDI for the home country include
The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings
The employment effects that arise from outward FDI
The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country
If the foreign subsidiary creates demand for home country export of capital equipment, intermediate goods, complementary products, etc.
This can create a positive impact in the home country employment.

28. What Are The Costs Of FDI To The Home Country?
The home country’s balance of payments can suffer
from the initial capital outflow required to finance the FDI
if the purpose of the FDI is to serve the home market from a low cost labor location
if the FDI is a substitute for direct exports
Employment may also be negatively affected if the FDI is a substitute for domestic production
But, international trade theory suggests that home country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid