Foreign Direct Investment

1. Foreign Direct Investment Chapter Sixteen Eitman, Stonehill, & Moffett Chapter 16 - Foreign Direct Investment

2. Absolute advantage (Smith) • Absoluteland • 0.2 productive units to produce 1 X • 0.3 productive units to produce 1 Y • Relativeland • 0.4 productive units to produce 1 X • 0.5 productive units to produce 1 Y • Absoluteland has absolute advantage in the production of both X and Y Chapter 16 - Foreign Direct Investment

3. Relative Advantage (Ricardo) • Absoluteland • The X price of Y is 0.67 • The Y price of X is 1.5 • Relativeland • The X price of Y is 0.8 • The Y price of X is 1.25 • Relative advantage • Absoluteland in X • Relativeland in Y Chapter 16 - Foreign Direct Investment

4. The world price of X and Y • Perfect world • Absoluteland specializes in Y • World X price of Y is between 0.67 and 0.8 • Relativeland specializes in X • World Y price of X is between 1.25 and 1.5 • Actual price • Evolution of trade will determine a common world price Chapter 16 - Foreign Direct Investment

5. Reasons for investment • markets • raw materials • production cost reduction • technology transfers • reduction of political risk Chapter 16 - Foreign Direct Investment

6. Government interference • Full employment policies • Tax breaks for automobile manufacturers • Economic development • Bombadier • Essential industries protected • Agriculture • Defence related industries • Boeing, McDonald/Douglas in the U.S. Chapter 16 - Foreign Direct Investment

7. Factors of production mobile • Capital • Very efficient world-wide capital markets • Flows of capital large • Multinationals easily transfer production • Technology • Intellectual property is very hard to protect • Labor • Illegal immigrants • Immigration policy Chapter 16 - Foreign Direct Investment

8. Factors of production substituted • Capital for labor (capital investment) • Labor for capital (outsourcing) • Technology transfers • Through subsidiaries • Through joint ventures Chapter 16 - Foreign Direct Investment

9. Economies of scale & scope • scale economies • production • finance • research & development • transportation • purchasing • marketing • scope economies • finance • marketing Chapter 16 - Foreign Direct Investment

10. Product & factor markets • new product markets • barriers to entry • reduction of barriers • factor markets • labour • money & capital • technology • goods • resource Chapter 16 - Foreign Direct Investment

11. Defensive investments • product cycle - cigarette industry • declining N. America, steady-state market in Europe, increasing Eastern Europe, Asia • follow the leader - China • conventional wisdom, huge market • horizontal or vertical integration • zero-sum game in home markets • growth leads to destructive competition • knowledge transfers Chapter 16 - Foreign Direct Investment

12. Modes of investment • Production at home and exporting • joint venture • merger • licensing agreement • management contract Chapter 16 - Foreign Direct Investment

13. Production at home, exporting • Advantages • Control • Less risk • Political risk • Disadvantages • High cost of labor • Transaction and operating exposure Chapter 16 - Foreign Direct Investment

14. Joint Venture • Advantages • partner has country specific knowledge • markets, politics, regulation • politicians prefer local ownership • Less transaction or operating exposure • Disadvantages • lack of control • financing, transfer pricing, strategy • valuation is difficult • Potential translation exposure Chapter 16 - Foreign Direct Investment

15. Mergers & Acquisitions • Advantages • economies of scale & scope • reduces operating exposure • obtain technology • Obtain markets • Transaction, operating exposure lower • Disadvantages • divergent corporate cultures • political opposition • valuation is difficult • Potential translation exposure Chapter 16 - Foreign Direct Investment

16. Strategic alliances • Advantages • exchanging stock • marketing agreements • cost sharing agreements • Disadvantages • Little control Chapter 16 - Foreign Direct Investment

17. Licensing • Advantages • No investment costs • Partner with knowledge of local markets • disadvantages • cash flow & transfer of knowledge • may create competitor Chapter 16 - Foreign Direct Investment

18. Political risk • change in rules which lead to reallocation of resources • tax rules • ownership rules/capital controls • restrictions of foreign ownership • exchange controls • change in political structure which portends reallocation of resources Chapter 16 - Foreign Direct Investment

19. Macro risks • expropriation • government seizure of property • valuation • book?? Market?? • exchange rates?? • time value of money • civil strife • investment in Yugoslavia, Russia?? • antagonistic governments • for US Iran , Cuba ?? Chapter 16 - Foreign Direct Investment

20. Micro risks - Government Policy Goals • employment policies • resource reallocation • taxes • transfers • trade policies • protectionism • balance of payments • exchange rate policy • economic development Chapter 16 - Foreign Direct Investment

21. Barriers • limitations to trade • quotas, embargoes, licensing, domestic content • administrative restrictions • fees, tariffs, deposit requirements, tax adjustments • non-economic discrimination • quality standards, environmental, health • direct government interference • procurement, export subsidies, domestic subsidies Chapter 16 - Foreign Direct Investment

22. Non-economic goal conflicts • economic emperialism • African economies • national security concerns • U.S. concern • corruption & nepotism • South, Central America, Africa, Asia • xenophobia • Asian economies Chapter 16 - Foreign Direct Investment

23. Assessing Political risk • political stability • probability of change • direction change would take • firm specific • negotiating terms • operating strategies to mitigate risk Chapter 16 - Foreign Direct Investment