Foreign Direct Investment

Foreign Direct InvestmentWhy is FDI increasing in the world economy?Why do firms often prefer FDI to other market entry strategies?Why do firms imitate competitors with FDI strategies?Why are certain locations favored for FDI?How does political ideology affect government FDI policy? What are key FDI related costs and benefits for receiving and source countries?

Foreign Direct InvestmentForeign direct investment (FDI): a firm invests directly in foreign facilities A firm that engages in FDI becomes a multinational enterprise (MNE)Multinational = more than one countryFactors which influence FDI are related to factors that stimulate trade

Foreign Direct InvestmentInvolves ownership of entity abroad forproductionMarketing/serviceR&DAccess of raw materials or other resourceParent has direct managerial controlDepending on its extent of ownership and On other contractual terms of the FDI

internalizationmarket failures (such as information costs, opportunism and asset specificity) are the main reason an MNE must use direct investment instead of licensing. An MNE with technological or marketing know-how has firm-specific advantages which are protected within its internal market. An MNE seeks expansion by direct investment when it has competitive advantages over other firms and the firm specific advantage needs to be protected by its organizational structure,

FDI Growth in the World EconomyFDI Outflow: $35 billion in 75 to $1.3 trillion in 00 to $653 billion in 03FDI Flow (from all countries): from 92 to 02 up 292%, compared to trade up 69% and world output up 28%FDI Stock: $3.5 trillion by 97 to > $7 trillion in 02In 02: 64,000 MNEs had:850,000 foreign affiliates 53 million employees $17.7 trillion in sales$8 trillions global exports Conclusion: FDI flow growing faster than world trade and world output

Forms of FDIFDI formsPurchase of assets: Quick entry, local market know-how, local financing may be possible, eliminate competitor, buying problemsNew investment: No local entity is available for sale, local financial incentives, no inherited problems, long lead time to generation of salesInternational joint-ventureShared ownership with local and/or other non-local partnerShared risk

Pattern of FDI ExplanationsInternational product life-cycle (Ray Vernon)Trade theory similarityEclectic paradigm of FDI (John Dunning)Combines ownership specific, location specific, and internalization specific advantages Explains FDI decision over a decision to enter through licensing or exports

Eclectic paradigm for FDI detail OLIOwnership advantage: creates a monopolistic advantage to be used in markets abroadUnique ownership advantage protected through ownership e.g., Brand, technology, economies of scale, management know-howLocation advantage: the FDI destination market must offer factors (land, capital, know-how, cost/quality of labor, economies of scale) that are advantageous for the firm to locate its investment there (link to trade theory)

Government Policy and FDIThe radical view: inbound FDI harmful; MNEsAre imperialist dominatorsExploit host to the advantage of home countryExtract profits from host country; give nothing backKeep LDCs backward and dependent for investment, technology and jobsThe free market view: FDI should be encouragedAdam Smith, Ricardo, et al: international production should be distributed per national comparative advantage

Host Country Effects of FDIBenefitsResource -transferEmploymentBalance-of-payment (BOP)Import substitution

CostsAdverse effects on the BOPCapital inflow followed by capital outflow + profitsProduction input importationThreat to national sovereignty and autonomyLoss of economic independence

MarketingReasons in brief FDIProduct upgradation and living style amelioration also ( product innovation)Price benefits ( low price world class quality)Promotion creativity and quality discountsHealthy compitition and modern distribution systemOther benefits ( employment, technology)

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