Foreign Direct Investment and Political Risk International Financial Management Dr. A. DeMaskey
Learning Objectives • How do firms become multinational? • Why do firms locate production overseas? • What is country risk? Political risk? • How do we measure political risk?
Exporting/Importing Licensing Franchising Joint Ventures Acquisitions De Novo Start Up Low Risk/Low Return Strategy (early phase)(intermediate phase) High Risk/High Return Strategy (advanced phase) Foreign Direct Investment How Do Firms Become MNCs?
Global Trends in FDI • Total annual worldwide FDI flows of $830 billion • FDI Outflows • Strong preference to invest in developed countries • Biggest targets are U.K. and Germany • Comparative advantages • FDI Inflows • U.S. is an attractive source of FDI • Other popular destinations include China, Mexico, and Spain • Locational advantages
Why Do Firms Invest Overseas? • Market Imperfections (Kindleberger (1969) and Hymer (1975)) • Imperfections in • Product Markets • Factor Markets • Capital Markets
Key Factors in Locating Production Overseas • Trade Barriers • Imperfect Labor Markets • Intangible Assets • Vertical integration • Product Life Cycle • Capital Market Imperfections Market Failure Imperfections
Political Risk and FDI • Risk of loss to the parent firm due to adverse political developments in the host country. • Outright expropriation • Unexpected changes in tax laws
Depending on incidence: Macro risk Micro risk Depending on manner: Transfer risk Operational risk Control risk Types of Political Risk
Examples of Political Risk • China in 1949 • Cuba in 1960 • Egypt in the early 1950s
POR Index Key Factors in Political Risk Analysis • Host country’s political and government system • Track records of political parties and their relative strength • Integration into the world system • Host country’s ethnic and religious stability • Regional security • Key economic indicators • Capital flight
Measuring Political Risk • In-house experts • Outside experts; • Morgan Stanley provides in-depth analysis of country/political risks • Euromoney provides country ratings by • Political risk • Credit risk • Economic performance
Economic and Political Factors Underlying Country Risk • Fiscal irresponsibility • Monetary instability • Controlled exchange rate system • Wasteful government spending • Quality of natural, human, and financial resources • Adjustment to external shocks • Market-oriented vs. statist policies
Useful Web Sites for Assessing Country Risk • What are the political and financial outlook for various countries? • Consult the Country Commercial Guides prepared by embassy staff at http://www.usatrade.gov/website/ccg.nsf/ccghomepage?openform. • Refer to the CIA’s World Factbook at http://www.odci.gov/. • Visit http://biz.yahoo.com/ifc/ More …
Useful Web Sites for Assessing Country Risk • How risky is your country? Look up: • http://www.worldbank.org/data/wdi2001/pdfs/tab5_2.pdf • http://www.prsgroup.com/icrg/icrg.html • http://www.institutionalinvestoronline.com/ • http://www.euromoney.com/ • http://www.moodys.com/moodys/cust/loadBusLine.asp?busLine=sovereign • http://www.standardpoor.com/