Foreign Direct Investment (FDI)
A firm invests directly in new facilities to produce or market in a foreign country.
Multinational enterprise
A firm engaged in FDI
What are two forms of FDI?
Two forms of FDI:
1. A greenfield investment
2. Acquisition or merging with an existing firm in the foreign country
Greenfield investment
The establishment of a wholly new operation in a foreign country
Flow of FDI
The amount of FDI undertaken over a given time period
What are two flows of FDI?
1. Outflows of FDI
2. Inflows of FDI
Outflows of FDI
The flows of FDI out of a country
Inflows of FDI
The flows of FDI into a country
Stock of FDI
The total accumulated value of foreign-owned assets at a given time
How has FDI grown more than world trade and world output?
FDI has grown more rapidly than world trade and world output because:
1. Firms still fear protectionist policies
2. The shift forward toward democratic political institutions and free market economies encourages FDI
3. Globalization is prompting firms to
Why do firms prefer FDI to either:
1. Exporting
2. Licensing
To answer this question, we need to look at the limitations of exporting and licensing, and the advantages of FDI
Exporting
Producing goods at home and then shipping them to the receiving country to sale
Licensing
Granting a foreign entity the right to produce and sell the firm's product in return for a royalty fee on every unit that the foreign entity sells
Why are acquisitions attractive?
Acquisitions are attractive because:
1. They are quicker to execute than greenfield investments
2. It is easier and less risky for a firm to acquire desired assets than build them from the ground up
3. Firms believe they can increase the efficiency of an
Theories of FDI
1. Limitations of Exporting
2. Limitations of Licensing
3. Advantages of Foreign Direct Investment
Limitations of Exporting
An exporting strategy can be limited by transportation costs and trade barriers
Limitations of Licensing: internalization theory (aka market imperfections) suggests:
1. Licensing could result in a firm's giving away valuable technological know-how to a potential foreign competitor
2. Licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required t
Advantages of Foreign Direct Investment
FDI will be favored over exporting when:
- Transportation costs are high
- Trade barriers are high
FDI will be favored over licensing when:
- The firm wants control over its technological know-how
- The firm wants control over its operations and business
What is common for firms in the same industry to do?
(The Pattern of FDI)
It is common for firms in the same industry to:
1. Have similar strategic behavior and undertake foreign direct investment around the same time
2. Direct their investment activities towards certain locations at certain stages in the product life cycle
The Pattern of FDI
1. Strategic Behavior Knickerbocker explored the relationship between FDI and rivalry in oligopolistic industries
- FDI flows reflect strategic rivalry between firms
This theory can be extended to multipoint competition
Oligopolistic industries
Industries composed of a limited number of large firms
Multipoint competition
When two or more enterprises encounter each other in different regional markets, national markets, or industries