7th ED Chapter 7 PPT

7/28/2019 7th ED Chapter 7 PPT

1/53

Copyri ght 2011 by The McGraw-H il l Companies, Inc. All ri ghts reserved.McGraw-Hill/Irwin

Global Business Today7e

by Charles W.L. Hill


2/53

7-2

Chapter 7

Foreign Direct

Investment


3/53

7-3

Introduction

Question: What is foreign direct investment?

Foreign direct investment (FDI) occurs when a firminvests directly in new facilities to produce and/or market

in a foreign country Once a firm undertakes FDI it becomes amultinational enterprise

There are two forms of FDI1. A greenfield investment- the establishment of a

wholly new operation in a foreign country2. Acquisition or merging with an existing firm in the

foreign country


4/53

7-4

FDI in the World Economy

There are two ways to look at FDI

1. The flow of FDI - the amount of FDI undertaken overa given time period

2. The stock of FDI - the total accumulated value offoreign-owned assets at a given time

Outflows of FDIare the flows of FDI out of a country

Inflows of FDI are the flows of FDI into a country


5/53

7-5

Trends in FDI

Both the flow and stock of FDI in the world economyhave increased over the last 20 years

FDI has grown more rapidly than world trade and worldoutput because

firms still fear the threat of protectionismthe general shift toward democratic political

institutions and free market economies hasencouraged FDI

the globalization of the world economy is promptingfirms to undertake FDI to ensure they have asignificant presence in many regions of the world


6/53

7-6

Trends in FDIFigure 7.1: FDI Outflows 1982-2009 ($ billions)


7/53

7-7

The Direction of FDI

Historically, most FDI has been directed at the developednations of the world, with the United States being a favoritetargetFDI inflows have remained high during the early 2000sfor the United States, and also for the European UnionSouth, East, and Southeast Asia, and particularly China,are now seeing an increase of FDI inflowsLatin America is also emerging as an important region forFDI


8/53

7-8

The Direction of FDIFigure 7.3: FDI Inflows by Region ($ billion), 1995 -2008


9/53


10/53


11/53

7-11

The Direction of FDIFigure 7.5: Cumulative FDI Outflows ($ billions),

1998 - 2008


12/53

7-12

The Form of FDI

Most cross-border investment involves mergers andacquisitions rather than greenfield investments

Acquisitions are attractive because

they are quicker to execute than greenfield

investmentsit is easier and less risky for a firm to acquire desired

assets than build them from the ground up

firms believe they can increase the efficiency of an

acquired unit by transferring capital, technology, ormanagement skills


13/53

7-13

Theories of FDI

Question: Why do firms prefer FDI to eitherexporting(producing goods at home and then shipping them to thereceiving country for sale) orlicensing(granting a foreignentity the right toproduce and sell the firms product in

return for a royalty fee on every unit that the foreignentity sells)?

Answer:

To answer this question, we need to look at thelimitations of exporting and licensing, and theadvantages of FDI


14/53

7-14

Theories of FDI

1. Limitations of Exporting - an exporting strategy can belimited by transportation costs and trade barriers

when transportation costs are high, exporting can beunprofitable

foreign direct investment may be a response to actualor threatened trade barriers such as import tariffs orquotas


15/53

7-15

Theories of FDI

2. Limitations of Licensing - has three major drawbacks

Internalization theory (also known as marketimperfections) suggests

1. it may result in a firms giving away valuable

technological know-how to a potential foreigncompetitor

2. it does not give a firm the tight control overmanufacturing, marketing, and strategy in a foreigncountry that may be required to maximize itsprofitability

3. It may be difficult if the firms competitive advantageis not amendable to licensing


16/53

7-16

Theories of FDI

3. Advantages of Foreign Direct Investment - a firm willfavor FDI over exporting whentransportation costs are hightrade barriers are high

A firm will favor FDI over licensing whenit wants control over its technological know-howit wants over its operations and business strategythe firms capabilities are not amenable to licensing


17/53

7-17

The Pattern of FDI

It is common for firms in the same industry to

1. have similar strategic behavior and undertakeforeign direct investment around the same time

2. direct their investment activities towards certainlocations at certain stages in the product life cycle


18/53

7-18

The Pattern of FDI

1. Strategic BehaviorKnickerbocker explored the relationship between FDI

and rivalry in oligopolistic industries (industriescomposed of a limited number of large firms)

Knickerbocker - FDI flows are a reflection of strategicrivalry between firms in the global marketplaceThis theory can be extended to embrace the concept of

multipoint competition (when two or more enterprisesencounter each other in different regional markets,national markets, or industries)


19/53

7-19

The Pattern of FDI

2. The Product Life Cycle

Vernon - firms undertake FDI at particular stages in thelife cycle of a product they have pioneered

firms invest in other advanced countries when localdemand in those countries grows large enough tosupport local production

firms then shift production to low-cost developingcountries when product standardization and marketsaturation give rise to price competition and costpressures


20/53

7-20

The Eclectic Paradigm

Dunnings eclectic paradigm - in addition to the variousfactors discussed earlier, two additional factors must beconsidered when explaining both the rationale for andthe direction of foreign direct investment

location-specific advantages- that arisefrom usingresourceendowments or assets that are tied to aparticular location and that a firm finds valuable tocombine with its own unique assets

externalities- knowledge spillovers that occur when

companies in the same industry locate in the samearea


21/53

7-21

Political Ideology and FDI

Ideology toward FDI has ranged from a radical stancethat is hostile to all FDI to the non-interventionistprinciple of free market economies

Between these two extremes is an approach that mightbe called pragmatic nationalism


22/53

7-22

The Radical View

The radical view - the MNE is an instrument of imperialistdomination and a tool for exploiting host countries to theexclusive benefit of their capitalist-imperialist homecountries

The radical view has been in retreat because of

the collapse of communism in Eastern Europe

the poor economic performance of those countriesthat had embraced the policy

the strong economic performance of developingcountries that had embraced capitalism


23/53

7-23

The Free Market View

The free market view - international production should bedistributed among countries according to the theory ofcomparative advantage

the MNE increases the overall efficiency of the world

economyThe United States and Britain are among the most open

countries to FDI, but both reserve the right to intervene


24/53

7-24

Pragmatic Nationalism

The pragmatic nationalist view is that FDI has bothbenefits, such as inflows of capital, technology, skills and

jobs, and costs, such as repatriation of profits to thehome country and a negative balance of payments effect

According to this view, FDI should be allowed only if thebenefits outweigh the costs

countries in the European Union try to attractbeneficial FDI flows by offering tax breaks and

subisides


25/53

7-25

Shifting Ideology

In recent years, there has been a strong shift toward thefree market stance creating

a surge in the volume of FDI worldwide

an increase in the volume of FDI directed at countriesthat have recently liberalized their regimes


26/53

7-26

Benefits and Costs of FDI

Question: What are the benefits and costs of FDI?

Answer:

The benefits and costs of FDI must be explored from theperspective of both the host (receiving) country and thehome (source) country


27/53

7-27

Host Country Benefits

The main benefits of inward FDI for a host country are

1. the resource transfer effect

2. the employment effect

3. the balance of payments effect4. effects on competition and economic growth


28/53

7-28


1. Resource Transfer Effects

FDI can bring capital, technology, and managementresources that would otherwise not be available

2. Employment Effects

FDI can bring jobs that would otherwise not be createdthere


29/53

7-29


3. Balance-of-Payments EffectsA countrys balance-of-payments accountis a record of a

countrys payments to and receipts from other countriesThe current accountis a record of a countrys export and

import of goods and servicesa current account surplus is usually favored over a

deficitFDI can help achieve a current account surplusif the FDI is a substitute for imports of goods and

servicesif the MNE uses a foreign subsidiary to export goods

and services to other countries


30/53

7-30


4. Effect on Competition and Economic Growth

FDI in the form of greenfield investment

increases the level of competition in a market

drives down pricesimproves the welfare of consumers

Increased competition can lead to

increased productivity growth

product and process innovationgreater economic growth


31/53

7-31

Host Country Costs

There are three main costs of inward FDI

1. the possible adverse effects of FDI on competitionwithin the host nation

2. adverse effects on the balance of payments

3. the perceived loss of national sovereignty andautonomy


32/53

7-32

Host Country Costs

1. Adverse Effects on Competition

The subsidiaries of foreign MNEs may have greatereconomic power than indigenous competitors becausethey may be part of a larger international organization

the MNE could draw on funds generated elsewhere tosubsidize costs in the local market

doing so could allow the MNE to drive indigenouscompetitors out of the market and create a monopolyposition


33/53

7-33

Host Country Costs

2. Adverse Effects on the Balance of Payments

There are two possible adverse effects of FDI on a hostcountrys balance-of-payments

1. with the initial capital inflows that come with FDImust be the subsequent outflow of capital as theforeign subsidiary repatriates earnings to its parentcountry

2. when a foreign subsidiary imports a substantial

number of its inputs from abroad, there is a debit onthe current account of the host countrys balance of

payments


34/53

7-34

Host Country Costs

3. National Sovereignty and Autonomy

FDI can mean some loss of economic independence

key decisions that can affect the host countryseconomy will be made by a foreign parent that has no

real commitment to the host country, and over whichthe host countrys government has no real control


35/53

7-35

Home Country Benefits

The benefits of FDI to the home country include

1. the effect on the capital account of the homecountrys balance of payments from the inward flow

of foreign earnings

2. the employment effects that arise from outward FDI

3. the gains from learning valuable skills from foreignmarkets that can subsequently be transferred backto the home country


36/53

7-36

Home Country Costs

The most important concerns for the home countrycenter around

1. The balance-of-payments

The balance of payments suffers from the initial

capital outflow required to finance the FDI The current account is negatively affected if the

purpose of the FDI is to serve the home marketfrom a low-cost production location

The current account suffers if the FDI is asubstitute for direct exports


37/53

7-37

Home Country Costs

2. Employment effects of outward FDI

If the home country is suffering fromunemployment, there may be concern about theexport of jobs


38/53

7-38

International Trade Theory and FDI

International trade theory - home country concerns aboutthe negative economic effects ofoffshore production(FDI undertaken to serve the home market) may not bevalid

FDI may actually stimulate economic growth byfreeing home country resources to concentrate onactivities where the home country has a comparativeadvantage

consumers may also benefit in the form of lowerprices


39/53

7-39

Government Policy and FDI

FDI can be regulated by both home and host countries

Governments can implement policies to

1. encourage FDI

2. discourage FDI


40/53

7-40

Home Country Policies

1. Encouraging Outward FDI

Many nations now have government-backed insuranceprograms to cover major types of foreign investment risk

can encourage firms to undertake FDI in politically

unstable nationsMany countries have also eliminated double taxation of

foreign income

Many host nations have relaxed restrictions on inbound

FDI


41/53

7-41

Home Country Policies

2. Restricting Outward FDI Virtually all investor countries, including the United

States, have exercised some control over outward FDIfrom time to timecountries manipulate tax rules to make it more

favorable for firms to invest at homecountries may restrict firms from investing in certain

nations for political reasons


42/53

7-42

Host Country Policies

1. Encouraging Inward FDI

Governments offer incentives to foreign firms to invest intheir countries

motivated by a desire to gain from the resource-

transfer and employment effects of FDI, and tocapture FDI away from other potential host countries


43/53

7-43

Host Country Policies

2. Restricting Inward FDI

Ownership restraints and performance requirements areused to restrict FDI

Ownership restraints -exclude foreign firms from certainsectors on the grounds of national security orcompetition

local owners can help to maximize the resourcetransfer and employment benefits of FDI

Performance requirements - used to maximize thebenefits and minimize the costs of FDI for the hostcountry


44/53

7-44

International Institutions and FDI

Until recently there has been no consistent involvementby multinational institutions in the governing of FDI

The formation of the World Trade Organization in 1995 ischanging this

The WTO has had some success in establishing auniversal set of rules to promote the liberalization ofFDI


45/53

7-45

Implications for Managers

Question: What does FDI mean for internationalbusinesses?

Answer:

The theory of FDI has implications for strategic behaviorof firms

Government policy on FDI can also be important forinternational businesses


46/53

7-46

The Theory of FDI

The location-specific advantages argument associatedwith Dunning help explain the direction of FDI

However, internalization theory is needed to explain whyfirms prefer FDI to licensing or exporting

exporting is preferable to licensing and FDI as long astransportation costs and trade barriers are low


47/53

7-47

The Theory of FDI

Licensing is unattractive whenthe firms proprietary property cannot be properly

protected by a licensing agreement

the firm needs tight control over a foreign entity in

order to maximize its market share and earnings inthat country

the firms skills and capabilities are not amenable tolicensing


48/53

7-48

The Theory of FDI

Figure 7.6: A Decision Framework


49/53

7-49

Government Policy

A host governments attitude toward FDI is important indecisions about where to locate foreign production facilitiesand where to make a foreign direct investment

A firms bargaining power with the host government is

highest whenthe host government places a high value on what the

firm has to offer

when there are few comparable alternatives available

when the firm has a long time to negotiate


50/53

7-50

Classroom Performance System

A company that establishes a new operation in a foreigncountry has made

a) An acquisition

b) A merger

c) A greenfield investment

d) A joint venture


51/53

7-51


Which of the following statements is true?a) Over the years, there has been a marked decrease inthe stock and flow of FDI

b) Over the years, there has been a marked increase in the

stock and flow of FDIc) Over the years, there has been a marked decrease inthe stock and an increase in the flow of FDI

d) Over the years, there has been a marked increase in thestock and an decrease in the flow of FDI


52/53

7-52


Advantages that arise from using resource endowments orassets that are tied to a particular location and that a firmfinds valuable to combine with its own unique assets are

a) First mover advantages

b) Location advantagesc) Externalities

d) Proprietary advantages


53/53


Benefits of FDI include all of the following except

a) The resource transfer effect

b) The employment effect

c) The balance of payments effectd) National sovereignty and autonomy

7th ED Chapter 7 PPT

Documents

Transcript of 7th ED Chapter 7 PPT