Foreign Direct Investment Chapter seven
FDA • Then main sections • Introduction • FDI in the world Economy • Theories of FDI • Political Ideology and FDI • Benefits and Cost of FDI • Govt Policy Instruments and FDI
Introduction • FDI when a firm invests directly in a foreign country leading to a multinational enterprise. • Two forms of FDI: • Greenfield investment http://www.sagia.gov.sa/PageFiles/4132/Annual_Report_FDI%20_SAUDI_ARABIA.pdf 2. Acquiring or merging with a firm in the foreign country. • See Telephonica case study
Foreign Direct Investment in the World Economysection number one Key concepts: • The Flow of FDI: the amount of the FDI undertaken over a year. • The Stock of FDI: the total accumulated value of foreign owned assets at a given time. • Outflows of FDI: the flow of FDI out of the country. • Inflows of FDI: the flow of FDI into a country
Foreign Direct Investment in the World Economy • Trends in FDI • The direction of FDI • The source of FDI • The form of FDI • The shift to services
Trends in FDI • Outflow of FDI from $25 billion in 1975 to 1.4 trillion in 2000. • 2007 = 1.8 trillion dollars • 2008 = 1.4 trillion. • 2011 = 1.66 trillion an increase by 16% • See http://www.twnside.org.sg/title2/finance/2012/finance120412.htm • See figure 1.7. • The global stock of FDI exceeded $15 trillion by 2007.
The directions of FDI • The direction from developed to developed countries. • $232billion in 2008 inward investment to the USA • EU reached 604 billion in 2007. • UK and France 323 and 272 respectively. • FDI into developing nations has increased to reach 27.4 billion. Don't forget the emerging economies, China for example • China attracted 60 billion of FDI in 2004 to hit 92 billion in 2008. • Gross fixed capital formation is an important indicator see figure 7.4
Source of FDI • USA since WWll up to 2000 • UK, France, Germany and Japan.
The form of FDI • Acquisitions Vs Greenfield Investments. • Acquisitions account for more than Greenfields up to 40-90 percent • Less in developing countries of about one-third is in the form of cross-border mergers and acquisitions. There are fewer firms to acquire in developing nations. Maybe you have to start from scratch- Greenfield investments
The form of FDI • Why to acquire vs undertake greenfield investments?
The Shift to Services • Services account for about more than 70% of the GDP • The shift to services is driven by many factors 1-including the shift from goods to services. 2-Services can not be traded internationally because of they are inseparable 3-Regime liberalization in services –telecommunication and power 4- the internet based global telecommunications networks has allowed some services to relocate some of their value creation activities to different nations- Proctor and Gample shifting its back office accounting function to the Philippines.
Theories of FDIsection number two Why FDI? Maybe it is more risky and expensive. Why not exporting and Licensing? What are their limitations?
Theories of FDI Limitations of exporting • Transportation costs and trade barriers Limitations of licensing • The risk of giving away valuable technological know how to a foreign potential competitor. Be careful of losing your secret formula. • Lost control over important functions like manufacturing, marketing and strategy. • The licensee might not be able to do it right affecting the firm’s competitive advantage. • Culture can not be licensed! Check Toyota example page 242. culture is immitigable
Theories of FDI The pattern of FDI or FDI pattern: firms in the same industry for example tend to undertake FDI at around the same time and towards certain locations. Theories that explain the pattern that we observe in FDI flows: 1-Strategic behaviour: One theory is based on the idea that FDI is based on strategic rivalry between firms
Theories of FDI 1-Strategic behaviour: One theory is based on the idea that FDI is based on strategic rivalry between firms • Example is the rivalry in oligopolistic industries • An oligopoly: like 4 firms control 80% of domestic market. Imitation is high in prices and DFI
Theories of FDI • Using Multipoint competition: when two or more companies encounter each other in different regional markets, national markets, or industries. Playing like chess, matching each other moves in different markets to try to get advantage one over the other. • The case of Kodak and Fuji • Burger King Following McDonald’s
Theories of FDI • The product life cycle is not very clear in terms of why firms use FDI not other forms like exporting or licensing! So shift to the Eclectic Paradigm is a very interesting one: • location-specific advantages for FDI including resource endowments or assets So it is: Location specific assets + firm’s own capabilities = FDI
Eclectic Paradigm • Look at the example of Silicon Valley – good example- on top of page 245. • The location specific advantage in Silicon Valley is KNOWLEDGE in computer and semiconductor industries attracting computer companies from all over the world to DFI there. Also oil companies.
Political Ideology and FDI(section number three) 1- the Radical view against FDI lead by Marxist political theory. 2- the Free Market View – Adam Smith and David Ricardo views theories. 3- Pragmatic Nationalism – the case of Al-Hassan City in Jordan. Japan weights benefits against costs of FDI- IBM and Texas instruments. Nissan, Toyota, and Honda are now operating in the UK by offering tax breaks and subsidies. The shift now is from the radical approach to the free market approach.
Benefits and costs of FDIsection four Host-country benefits • Resource-transfer Effects-like capital, technology, and management resources and training managers and job creation- THE KNOW-HOW. • Balance of payments effects; avoiding trade deficit. China exports reached $969 Billion in 2006 due to the presence of foreign multinationals that invested heavily in China during the 1990.
Benefits and costs of FDIsection four • Effects on competition and economic growth This improves prices, quality and economic prosperity, R&D., productivity.
Benefits and costs of FDIsection four Host-country costs: • Adverse effects on competition • Adverse effects on the balance of payments • National sovereignty and autonomy Home country benefits: home country balance of payments, employment and skill development Home country costs-balance of payments and employment
Govt Policy instruments and FDIsection number five • Home country policies • Host country policies
Home country policies • Encouraging outward FDI • Restricting outward FDI • The first one: encouraging outward FDI: 1- insurance 2- elimination of double taxation Using political influence to relax restriction, barriers and rules. The Case of toys “R” Us in Japan
Home country policies • The second policy is restricting outward FDI 1- to limit capital outflows for protecting the country balance of payments 2- to create jobs at home 3- for political reasons. Ex Iran.
Host country policies • Encouraging inward FDI Tax concessions, low interest loans, and grants France and UK compete for inward FDI from Toyota in 1995. • Restricting inward FDI In ownership restraints and performance requirements. For example Inward FDI in Natural resources like water, cement and potash and other minerals National security issues
Restricting inward FDI • Ownership restraints is also based on a belief that local owners can help to maximize the resource transfer and employment benefits. • International institutions and FDI Liberalization page 256.
Chapter summary and guidelines You need to: • Know the differences between Greenfield investments Vs acquisitions. • FDI keywords like flow of FDI...etc. • View links related to FDI in these slides. • Have a general knowledge about trends in FDI, direction, and sources of FDI. • The shift to services • Know the theories of FDI including the internalization theory, strategic behaviour, multipoint competition.
Chapter summary and guidelines • More important is the eclectic paradigm- • In The political ideology page 245 look at the 3 views. • Benefits and cost of FDI – the main elements only like 2-3 benefits and costs of each. and • the same thing for govt policy instruments. Case studies (opening and closing). Good luck to you.