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Why Do Companies Invest Overseas?. Krishna G Iyer Department of Applied and International Economics Massey University, Palmerston North. Outline of the Presentation. Define overseas/foreign investment. Types of foreign investment. Foreign direct investment and Multinational Enterprises.

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why do companies invest overseas

Why Do Companies Invest Overseas?

Krishna G Iyer

Department of Applied and International Economics

Massey University, Palmerston North.

outline of the presentation
Outline of the Presentation
  • Define overseas/foreign investment.
  • Types of foreign investment.
  • Foreign direct investment and Multinational Enterprises.
  • Statistical highlights: Macro-level Data.
  • What drives FDI – Micro factors.
  • Shareholder portfolio diversification.
  • Revenue related objectives.
  • Cost related objectives.
  • Trojan Horse Theory.
  • Incentives and Barriers to FDI.
  • Conclusion.
types of investment
Types of Investment
  • Foreign Direct Investment (FDI) – Multinational Enterprise (MNE).
  • Foreign Portfolio Investment (FPI)
  • Other Foreign Investment (OFI)
fdi as share of gdp
FDI as share of GDP

FDII and FDIO Flows as Percentage of GDP (1980-2004)

the micro story why do firms invest overseas
The Micro-Story: Why do firms invest overseas?
  • Shareholder Diversification Services.
  • Revenue Related Motives.
  • Cost Related Motives.
  • Trojan Horse Theory.
shareholder diversification services
Shareholder diversification services
  • Don’t put all your eggs in one basket.
  • International Stock Market Correlations are low – thus portfolio risk might converge to the systematic risk.
  • FDI provides indirect diversification services.
  • Little empirical evidence favoring this thesis.
  • In any case, reducing barriers to FPI makes this motive, if it ever existed, less important.
revenue related motives
Revenue Related Motives
  • New markets.
  • Enter markets with superior profits.
  • Exploit intangible assets.
  • Reacting to trade barriers.
  • International business diversification.
new markets
New Markets
  • Establish a subsidiary or acquire a competitor – Greenfield Investments / joint ventures / cross-border mergers and acquisitions.
  • E.g. Blockbuster Entertainment Corp. – entering the rest of the OECD.
  • Coca-Cola and Pepsi in China and India.
  • FORD, HP, IBM.
  • YUM Brands – KFC Franchises.
  • Firm Level Surveys indicates access to new markets as the primary determinant of FDI (PC - Australia).
markets with superior profits
Markets with superior profits
  • MNE’s are attracted to markets with superior profits.
  • When profit margins are squeezed in the domestic market – foreign markets may be worth exploring.
  • Related to the Product Life Cycle theory of Vernon (1966).
  • Entry may trigger a price war and defeat the purpose of FDI – E.g. the Mobile Phone Industry in Asia and more recently India. Joint Ventures may then be preferred.
exploit intangible assets
Exploit Intangible Assets
  • Comparative advantage of MNE’s off-setting the inherent disadvantages vis-à-vis domestic firms.
  • The intangible assets may take the form of technology, marketing know-how, superior R&D capabilities, brand name and recognition.
  • Hard to package and sell intangible assets to foreign firms. Further, property rights are difficult to establish and protect in foreign countries – So FDI emerges, often, as the best way to exploit intangible assets.
  • The Coca-Cola Story in India.
reacting to existing potential trade barriers
Reacting to Existing/Potential Trade Barriers
  • Transportation costs.
  • Circumvent trade barriers – E.g. Japanese televisions in US.
  • Pre-empt trade barriers – E.g. Japanese automobiles in US.
  • Surge of FDI in Mexico (NAFTA) and Spain and newer members of EU.
international business diversification
International Business Diversification
  • Reducing overall risk via international diversification – low correlation once again the key.
  • The Enron Story.
cost related motives
Cost Related Motives
  • Exploiting economies of scale.
  • Access to raw materials / inputs.
  • Labor market imperfection.
  • Exchange Rate Movements.
exploiting economies of scale
Exploiting Economies of Scale
  • Lower average cost per unit resulting from increased production.
  • Also relates to the revenue related objective of exploiting intangible assets.
  • E.g. Consolidation of US MNEs in Europe since the Single European Act.
  • Specific examples include: General Motors – Poland, Peugeot – Czech Republic, Toyota – Slovakia, Audi – Hungary, Renault – Romania, Volkswagen – Slovenia.
access to raw materials inputs
Access to raw materials / inputs
  • Transportation costs – bulky raw materials.
  • Ensuring inputs supply stability.
  • E.g. SKF the Swedish ball-bearing manufacturer.
labor market imperfection
Labor Market Imperfection
  • Labor services in a country can be severely under-priced relative to its productivity.
  • Labor is not perfectly mobile across countries.
  • Surging FDI in Mexico, China, India, Thailand, Indonesia, Malaysia often attributed to low cost of labor.
  • Revisiting examples:General Motors – Poland, Peugeot – Czech Republic, Toyota – Slovakia, Audi – Hungary, Renault – Romania, Volkswagen – Slovenia (Spain – Germany Link).
  • Surge of FDI in Mexico (NAFTA) and Spain (EU).
exchange rate movements
Exchange Rate Movements
  • Undervalued currency may encourage FDI since initial outlay is likely to be low.
  • Empirical evidence is not clear.
trojan horse hypothesis
Trojan Horse Hypothesis
  • Has been the hot topic over the last few years.
  • Rising Sun – the book by Michael Crichton has several references to this theory.
  • To revisit the Trojan Horse Story.
  • Trojan Computer Virus – and now Trojan FDI.
  • Van Pottelsberghe and Lichtenberg (1996, 1998 and 2001) say FDI is essentially driven by the desire to acquire technology.
  • At the aggregate level, almost no evidence is found. But what does the market say?
average wealth gains from cross border acquisitions foreign acquisitions of us firms eun et al 1996
Average Wealth Gains from Cross-Border Acquisitions: Foreign Acquisitions of US Firms (Eun et al. 1996)
returning to the macro level incentives for fdi
Returning to the macro level - Incentives for FDI
  • Widely held view that FDI offers substantial benefits for host economies – technology, employment, export revenue, consumer choice, increased competition etc.
  • Empirical evidence is ambiguous.
  • Incentives include tax breaks, rent-free land and buildings, low interest loans, subsidized energy, reduced environmental regulations. Classic examples – Finland and Ireland 1990s.
  • With tax breaks there is always the possibility of round tripping – China and India are examples.
  • Incentives must be carefully weighed – easy to go overboard.
barriers to fdi
Barriers to FDI
  • Barriers placed by Government agencies.
  • E.g. France, Australia. Japan has a historically imposed barriers on acquisitions.
  • Restricted Ownership rules in several developing countries – can be effectively used to reduce political risk of FDI.
  • Conditions – Employment related conditions (American Universities in the Middle East), Acquisition of Inputs from local sources e.g. Mexico, Export conditions, E.g. Spain, etc.
  • Red Tape / Corruption.
  • Large and Increasing Magnitudes of FDI – a trend certain to continue in the future.
  • Why do firms undertake FDI?
  • Is it beneficial for host and source economies?
  • What sort of incentives are being offered?
  • What kind of barriers exist?
  • Weighing the Costs and Benefits.