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
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 assets at a given time
- Outflows of FDI are the flows of FDI out of a country
- Inflows of FDI are
Trends In FDI
- There has been a marked increase in both the flow and stock of FDI in the world economy over the last 30 years
FDI has grown more rapidly than world trade and world output because:
- firms still fear the threat of protectionism
- the general shift towar
The Direction of FDI (1/2)
- Most FDI has historically been directed at the developed nations of the world, with the United States being a favorite target
- FDI inflows have remained high during the early 2000s for the United States, and also for the European Union
- South, East, a
The Direction of FDI (2/2)
- Gross fixed capital formation summarizes the total amount of capital invested in factories, stores, office buildings, and the like
- All else being equal, the greater the capital investment in an economy, the more favorable its future prospects are like
The Form Of FDI: Acquisitions Versus Greenfield Investments
- Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments
- Firms prefer to acquire existing assets because:
- mergers and acquisitions are quicker to execute than greenfield investments
- it is easier an
The Shift to Services
- FDI is shifting away from extractive industries and manufacturing, and towards services
The shift to services is being driven by:
- the general move in many developed countries toward services
- the fact that many services need to be produced where they
Why Foreign Direct Investment? (1/3)
Why do firms choose FDI instead of:
- exporting - producing goods at home and then shipping them to the receiving country for sale
or
- licensing - granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on e
Why Foreign Direct Investment? (2/3)
- An export strategy can be constrained by transportation costs and trade barriers
- Foreign direct investment may be undertaken as a response to actual or threatened trade barriers such as import tariffs or quotas
Why Foreign Direct Investment? (3/3)
- Internalization theory (also known as market imperfections
theory) suggests that licensing has three major drawbacks:
- licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor
- licensing does not g
The Pattern Of Foreign Direct Investment (1/3)
- Firms in the same industry often undertake foreign direct investment around the same time and tend to direct their investment activities towards certain locations
- Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic indust
The Pattern Of Foreign Direct Investment (2/3)
- Vernon argued that firms undertake FDI at particular stages in the life cycle of a product they have pioneered
- Firms invest in other advanced countries when local demand in those countries grows large enough to support local production, and then shift
The Pattern Of Foreign Direct Investment (3/3)
- According to the eclectic paradigm, in addition to the various factors discussed earlier, it is important to consider:
- location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a
Political Ideology And Foreign Direct Investment
- Ideology toward FDI ranges from a radical stance that is hostile to all FDI to the non-interventionist principle of free market economies
- Between these two extremes is an approach that might be called pragmatic nationalism
The Radical View
- The radical view traces its roots to Marxist political and economic theory
- It argues that the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countri
The Free Market View
- According to the free market view, international production should be distributed among countries according to the theory of comparative advantage
- The free market view has been embraced by a number of advanced and developing nations, including the Uni
Pragmatic Nationalism
- Pragmatic nationalism suggests that FDI has both benefits, such as inflows of capital, technology, skills and jobs, and costs, such as repatriation of profits to the home country and a negative balance of payments effect
- According to this view, FDI sh
Shifting Ideology
-Recently, there has been a strong shift toward the free
market stance creating:
- a surge in FDI worldwide
- an increase in the volume of FDI in countries with newly liberalized regimes
Host-Country Benefits (1/3)
There are four main benefits of inward FDI for a host
country:
1. resource transfer effects - FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available
2. employ
Host-Country Benefits (2/3)
3. balance of payments effects - a country's balance-of-payments account is a record of a country's payments to and receipts from other countries.
- The current account is a record of a country's export and import of goods and services
- Governments typic
Host-Country Benefits (3/3)
4. effects on competition and economic growth - FDI in the form of greenfield investment increases the level of competition in a market, driving down prices and improving the welfare of consumers
- Increased competition can lead to increased productivity
Benefits of FDI include all of the following except
- The resource transfer effect
- The employment effect
- The balance of payments effect
** National sovereignty and autonomy
Host- Country Costs (1/3)
Inward FDI has three main costs:
1. the possible 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 org
Host- Country Costs (2/3)
2. adverse effects on the balance of payments
- with the initial capital inflows that come with FDI must be the subsequent outflow of capital as the foreign subsidiary repatriates earnings to its parent country
- when a foreign subsidiary imports a substa
Host- Country Costs (3/3)
3. the perceived loss of national sovereignty and autonomy
- key decisions that can affect the host country's economy 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 rea
Home-Country Benefits
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 valuabl
Home-Country Costs
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
- Empl
Home-Country Policies (1/2)
Governments can encourage and restrict FDI:
- To encourage outward FDI, many nations now have government-backed insurance programs to cover major types of foreign investment risk
- To restrict outward FDI, most countries, including the United States, limi
Host-Country Policies (2/2)
Governments can encourage or restrict inward FDI
- To encourage inward FDI, governments offer incentives to foreign firms to invest in their countries
- Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI,
International Institutions And The Liberalization Of FDI
- Until the 1990s, there was no consistent involvement by multinational institutions in the governing of FDI
- Today, the World Trade Organization is changing this by trying to establish a universal set of rules designed to promote the liberalization of F
Government Policy
- A host government's attitude toward FDI is an important variable in decisions about where to locate foreign production facilities and where to make a foreign direct investment