foreign direct investment l.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
Foreign Direct Investment PowerPoint Presentation
Download Presentation
Foreign Direct Investment

Loading in 2 Seconds...

play fullscreen
1 / 83

Foreign Direct Investment - PowerPoint PPT Presentation


  • 240 Views
  • Uploaded on

Foreign Direct Investment. Question for Today: Why does investment capital flow from some economies to others?. Why Does Capital Flow?. According to optimal investment analysis... Whenever returns are different in two countries. According to the Balance of Payments Equation...

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'Foreign Direct Investment' - Jimmy


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
why does capital flow
Why Does Capital Flow?

According to optimal investment analysis...

Whenever returns are different in two countries.

According to the Balance of Payments Equation...

It doesn’t have much choice.

That is, it must flow into any country that is investing more than it is saving.

the macdougall diagram of international investment flows
The MacDougall Diagramof International Investment Flows

Model for understanding the interaction of supply of and demand for investment capital in different countries.

Provides us with a benchmark for interpreting cross-border capital movements.

Simple but quite useful

optimal international investment

Optimal International Investment

x-axis measures total capital available for investment in a country

O

Capital

optimal international investment6

Optimal International Investment

y-axis reflects the prevailing rate of return per unit of capital (i.e. per $) available in a country.

r

(rate of

return)

O

Capital

optimal international investment7

Optimal International Investment

Then draw a line which reflects the prevailing rate of return in an economy, depending on the total stock of capital.

r

(rate of

return)

O

Capital

optimal international investment8

Optimal International Investment

Why does the line slope downward?

r

(rate of

return)

O

Capital

optimal international investment9

Optimal International Investment

If a country only has one unit of capital, the rate of return must be high.

r

(rate of

return)

O

Capital

optimal international investment10

Optimal International Investment

If a country only has one unit of capital, the rate of return must be high.

r

(rate of

return)

Lots of land, lots of workers, little equipment, few factories.

O

Capital

optimal international investment11

Optimal International Investment

r

(rate of

return)

As more capital is around competing, land becomes scarce and workers become expensive.

O

Capital

optimal international investment12

Optimal International Investment

r

(rate of

return)

If k is the total stock of capital in a particular country

O

Capital

k

optimal international investment13

Optimal International Investment

r

(rate of

return)

Then r0 is the prevailing interest rate in the economy.

r0

O

Capital

k

optimal international investment14

Optimal International Investment

r

(rate of

return)

The shaded area then represents the economy’s gross domestic product (GDP).

r0

O

Capital

k

optimal international investment15

Optimal International Investment

Now consider a second country with a different (better) schedule of return possibilities...

r

(rate of

return)

O

Capital

k

optimal international investment16

Optimal International Investment

Now consider a second country with a different (better) schedule of return possibilities...

r

(rate of

return)

O

Capital

k

optimal international investment17

Optimal International Investment

a lower supply of capital...

r

(rate of

return)

O

k

k

Capital

optimal international investment18

Optimal International Investment

a lower supply of capital...

r

(rate of

return)

O

k

Capital

optimal international investment19

Optimal International Investment

and therefore a higher prevailing interest rate.

r

(rate of

return)

r0

O

k

Capital

optimal international investment20

Optimal International Investment

r

(rate of

return)

Denoting variables of this second (call it ‘foreign’) country with asterisk.

r0*

O*

k*

Capital

slide24

How far over do we bring it?

r

(rate of

return)

r0*

r0

O

O*

Capital

k

k*

slide25

Until the length of the horizontal axis represents the total quantity of capital in the two economies...

r

(rate of

return)

r0*

r0

O

O*

Capital

k

k*

slide26

So that the length from 0 to k0 is the amount of capital in the domestic economy...

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide27

So that the length from 0* to k0 is the amount of capital in the foreign economy...

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide28

Now what happens if both countries allow capital to flow freely between them?

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide30

Whereas capital in the foreign country is earning a higher return of r0*

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide31

So owners of capital in the home country will begin to move capital overseas...

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide32

Shifting k to the left

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide33

Increasing the supply of capital in the foreign country

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide34

Decreasing the supply of capital in the home country

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide35

Increasing interest rates in the home country

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide36

And decreasing the returns to capital in the foreign country

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide37

When will the flows of capital from the home to the foreign country cease?

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide38

When incentives to transfer capital no longer exist...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide39

When rates of return to capital are equated: when r1 = r1*

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide40

This concept is know as:

Real Interest Parity

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

example japan 1980
Example: Japan 1980

Japan has severe capital controls in place.

Japanese investors are largely restricted from holding foreign assets.

Returns in rest of the world - especially high interest rates in U.S. - appear attractive to Japanese.

Japan has $11 billion in net inflows.

slide42

Japan in 1980.

r

(rate of

return)

r0*

r0

O

O*

Capital

k0

slide43

Example: Japan 1980

In December, Japan passes Foreign Exchange and Foreign Trade Control Law.

Large pool of savings Japan has built up over the years slosh onto world capital markets.

Japanese $11 billion inflows become $21 billion in outflows by 1983 and $87 billion by 1987.

slide45

The foreign country’s GDP increases from this...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide46

to this.

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide47

The home country loses some GDP...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide48

The home country loses some GDP...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide49

But total world production has now increased by this amount.

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide50

For use of the home country’s capital, the foreign country pays r1* times the amount borrowed.

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide51

GNP (which equals GDP + Overseas Income) is therefore...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide52

So the home country GNP increases by...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

slide53

Similarly, after paying the interest bill, the foreign GNP increases by...

r

(rate of

return)

r0*

r1*

r1

r0

O

O*

Capital

k1

k0

examples
Examples

1. Europe: post-W.W.II.

2. Latin America: recent deregulation and privatization.

3. Australia: early 1900s.

international capital flows
International Capital Flows

Having developed a basic understanding of why capital flows between countries, remember that these flows can take three main forms:

Portfolio Investment - ownership of corporate stocks, bonds, government bonds, and other bonds.

Intermediated Investment - short and long-term bank lending and deposit-taking activity.

Foreign Direct Investment - investment obtaining ownership of greater than 10% of voting shares in a foreign firm.

Why FDI? Why do we need multinationals?

slide56

Important FDI Facts

1. FDI has grown rapidly since W.W.II and especially in the last 15 years. FDI stock, by host country, $bn:

slide57

Empirical Facts (cont’d)

2. Developing countries account for an increasing share of inflows:

- in 1995 developing countries received a record $100 of $315 billion in inflows.

- excluding intra-European flows, developing countries received 60% of all flows in 1995 - up from 17% in 1989.

3. Most FDI flows (97%) originate in developed countries.

4. Much two-way FDI flows (‘cross-hauling’) takes place between pairs of developed countries - even at industry level.

slide58

Empirical Facts (cont’d)

5. Most FDI production is sold in recipient country.

6. Degree of FDI varies widely across and within industry. (examples Pepsi vs. Coke and Banks vs. Food).

7. Multinationals tend to have:

- high levels of R&D

- large share of professional and technical workers

- products that are new or technically complex

- high levels of advertising and product differentiation.

- high values of intangible assets vs. market value.

slide59

Empirical Facts (cont’d)

8. Most of US corporations’ international exposure is through FDI - not exports:

- In-country sales of US foreign affiliates were $1.8 trillion in 1995 vs $576 billion in exports.

- US foreign affiliates exported more than the US domestic operations in 1995: $580 vs. $576.

9. 80% of US FDI is via M&A - not greenfield investment.

10. US FDI:

slide60

Empirical Facts (cont’d)

8. Most of US corporations’ international exposure is through FDI - not exports:

- In-country sales of US foreign affiliates were $1.8 trillion in 1995 vs $576 billion in exports.

- US foreign affiliates exported more than the US domestic operations in 1995: $580 vs. $576.

9. 80% of US FDI is via M&A - not greenfield investment.

10. US FDI:

1. Europe - 50%

2. Latin America - 18.1%

3. Canada - 11.5%

4. Japan, Australia, NZ - 9.3%

5. Rest of Asia - 9%

slide62

Emerging Market FDI: Top Recipients

1980

1. Brazil

2. South Africa

3. Indonesia

4. Mexico

5. Singapore

6. Argentina

7. Malaysia

8. Greece

9. Taiwan

10. Venezuela

slide63

Emerging Market FDI: Top Recipients

1980

1995

1. Brazil

2. South Africa

3. Indonesia

4. Mexico

5. Singapore

6. Argentina

7. Malaysia

8. Greece

9. Taiwan

10. Venezuela

1. China

2. Mexico

3. Singapore

4. Indonesia

5. Brazil

6. Malaysia

7. Argentina

8. Hong Kong

9. Greece

10. Thailand

three questions
Three Questions:

1. What explains locational patterns of FDI? Why do some countries tend to be host countries and some source countries?

2. Why is FDI undertaken instead of portfolio investment or intermediated investment? What ‘overcompensating’ ownership advantage do foreigners have over domestic investors?

3. Why does cross-hauling exist? Why do some countries invest directly in each other?

what explains locational patterns of fdi
What Explains Locational Patterns of FDI?

What are some reasons certain countries are chosen over others as targets for multinational investment?

what explains locational patterns of fdi66
What Explains Locational Patterns of FDI?

What are some reasons certain countries are chosen over others as targets for multinational investment?

1. Labor costs

2. Access to resources

3. Government policies

4. Expanding markets

5. Currency values

6. Tax advantages

7. Investment climates

why fdi over portfolio or intermediated investment
Why FDI over Portfolio or Intermediated Investment?

For FDI to be considered, the foreign investor must view: r*FDI > r*PI,II

From the perspective of the host country, it must be the case that: r*FDI > r*local investment

But these inequalities are the same, since local investors will equate: r*PI, II = r*local investment

what makes the return on fdi greater than that on pi or ii
What Makes the Return on FDI greater than that on PI or II?

In other words, how do foreign corporations outperform domestic ones on the latter’s home turf?

Especially considering the foreign firm must incur additional costs of travel, communication, and monitoring...

...and the foreign firm must contend with unfamiliar legal, distributing, and accounting systems.

Thus, an understanding of FDI must identify what ‘overcompensating advantage’ a foreign firm has over domestic competition, making returns to FDI greater than those to Portfolio or Intermediated Investment.

slide69

Example: Samsung of Korea

In 1996, Samsung, and many other companies in South Korea, Hong Kong, Singapore, Taiwan, and Thailand, were faced with ‘going multinational in order to survive’.

For many firms of the ‘Asian Tigers’, domestic labor costs have become too high to make low-tech manufacturing economical.

They look to outsource production or product assembly in lower-cost countries.

slide70

Example: Samsung of Korea

Samsung pays its average worker in Seoul $12.70/hour.

Similar work could be performed in Malaysia for $2/hour and in China for $.85/hour.

In outsourcing production to Malaysia, Samsung must become a multinational - and invest directly in Malaysian production facilities.

Why?

slide71

Example: Samsung of Korea

As a multinational, Samsung feels it can more efficiently:

1. invest directly in Malaysia

2. raise needed capital in Hong Kong

3. safely transfer patented technology to foreign affiliates

4. efficiently ship parts between assembly plants

5. sell products throughout region

slide72

Major Theories of FDI:

1. Technological Advantages

Firm-specific advantages include:

1. Proprietary technology and patent protection

2. Proprietary information

3. Production secrets

4. Superior management organization

5. Brand-name recognition or trademark protection

6. Marketing skills

...

slide73

2. Product Cycle Theory

Product development is characterized by different stages:

Stage 1: Production in industrialized countries

- feedback from customers

- skilled labor

- high demand (for new product) covers high labor costs.

Stage 2: Production in developing countries for export

- Product faces more competitors, tougher price competition.

- Production has become standardized; production can move to markets with plentiful, cheap unskilled labor for export.

...

slide74

3. Oligopoly Models

Firms gain benefits from being sufficiently large to operate multinationally:

A. Firms ‘think internationally’ when designing new products in order to capture economies of scale (i.e. absorb high R&D expenditures).

B. Local production improves foreign market penetration beyond that achieved through exporting.

C. Local production to obtain knowledge-transfers from competitors.

...

slide75

4. Internalization Theory

Based on theory of firm developed by Ronald Coase.

Firms integrate across borders when use of market is costly and inefficient for certain transactions:

- Enforceability of contracts

- Taxes paid on market transactions

- Difficulty defining prices

- Default risks associated with contracts.

Of course, internalization is costly as well.

...

slide76

5. Imperfections in Securities Markets

When organized markets for equity and debt are illiquid or non-existent, FDI is a substitute for PI.

FDI obtains otherwise inaccessible high returns in markets with no organized securities markets.

FDI offers some (albeit weak) direct diversification benefits.

...

slide77

6. Exchange Risk Theory

Investors are risk-averse.

As a result, they do not entirely arbitrage real returns across countries via portfolio and intermediated investment.

With FDI, management can structure operations (i.e. via multiple sourcing) to reduce currency risks below those of PI and II.

Other option-type benefits exist with respect to interest rate and labor cost fluctuations.

...

slide78

Key Points

1. FDI flows are growing at tremendous rate - especially those directed towards emerging markets.

2. For investors to consider an overseas project (FDI), there must exist some ‘overcompensating advantage’ so that:

- returns are higher than those obtained by local competition

- returns from FDI exceed those of Portfolio or Intermediated Investment

in order to compensate for costs of doing business transnationally.

3. A number of theories of FDI identify sources of these ‘overcompensating advantages.’

long term risky investments frequently misevaluated
Long-Term Risky Investments Frequently Misevaluated
  • 1. Test marketing the first of a proposed new family of products.
  • 2. Installing a revolutionary new processing technique.
  • 3. Research and development and the pilot plant that will be required if the research is successful.
  • 4. Acquiring a greenfield industrial site.
  • 5. Acquiring telecommunications or logistics facility that could radically alter the future distribution of services.
  • 6. Obtaining mineral rights at a site that will require extensive development.

These are all call options

example project description
Example Project Description
  • Phase 1: New product development
    • $18 million annual research cost for 2 years
    • 60% probability of success
  • Phase 2: Market development
    • Undertaken only if product development succeeds
    • $10 million annual expenditure for 2 years on the development of marketing and the establishment of marketing and distribution channels (net of any revenues earned in test marketing)
  • Phase 3: Sales
    • Proceeds only if Phase 1 and Phase 2 verify opportunity
    • Production is subcontracted
project assumptions
Project Assumptions

The results of Phase 2 (available at the end of year 4) identify the

product's market potential

expected value calculations
Expected Value Calculations

expected IRR = 10.1%

expected phase iii values
Expected Phase III Values

Expected value = $136 million