Foreign Direct Investment

in new facilities to produce and/or market in a foreign

country
Once a firm undertakes FDI it becomes a multinational enterprise

FDI can be:
greenfield investments - the establishment of a wholly new operation in a foreign country
acquisitions or mergers with existing firms in the foreign country

refers to the amount of FDI undertaken over a given

time period
The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time
Outflows of FDI are the flows of FDI out of a country
Inflows of FDI are the flows of FDI into a country

the flow and stock of FDI in the world economy

over the last 30 years

FDI has grown more rapidly than world trade and world output because:
firms still fear the threat of protectionism
the general shift toward democratic political institutions and free market economies has encouraged FDI
the globalization of the world economy is having a positive impact on the volume of FDI as firms undertake FDI to ensure they have a significant presence in many regions of the world

the developed nations of the world, with the United States

being a favorite target
FDI inflows have remained high during the early 2000s for the United States, and also for the European Union
South, East, and Southeast Asia, and particularly China, are now seeing an increase of FDI inflows
Latin America is also emerging as an important region for FDI

billion), 1995-2006

amount of capital invested in factories, stores, office buildings, and

the like
All else being equal, the greater the capital investment in an economy, the more favorable its future prospects are likely to be
So, FDI can be seen as an important source of capital investment and a determinant of the future growth rate of an economy

of Gross Fixed Capital Formation 1992-2005

been the largest source country for FDI
The United Kingdom, the

Netherlands, France, Germany, and Japan are other important source countries

1998-2005

is in the form of mergers and acquisitions rather than

greenfield investments

Firms prefer to acquire existing assets because:
mergers and acquisitions are quicker to execute than greenfield investments
it is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground up
firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

and manufacturing, and towards services

The shift to services is

being driven by:
the general move in many developed countries toward services
the fact that many services need to be produced where they are consumed
a liberalization of policies governing FDI in services
the rise of Internet-based global telecommunications networks

use exporting or licensing to enter foreign markets?
Why do firms

from the same industry undertake FDI at the same time?
How can the pattern of foreign direct investment flows be explained?

- producing goods at home and then shipping them to

the receiving country for sale
or
licensing - granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells

transportation costs and trade barriers
Foreign direct investment may be

undertaken as a response to actual or threatened trade barriers such as import tariffs or quotas

theory) suggests that licensing has three major drawbacks:
licensing may result

in a firm’s giving away valuable technological know-how to a potential foreign competitor
licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability
a problem arises with licensing when the firm’s competitive advantage is based not so much on its products as on the management, marketing, and manufacturing capabilities that produce those products

often undertake foreign direct investment around the same time and

tend to direct their investment activities towards certain locations
Knickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms) and suggested that FDI flows are a reflection of strategic rivalry between firms in the global marketplace
The theory can be extended to embrace the concept of multipoint competition (when two or more enterprises encounter each other in different regional markets, national markets, or industries)

FDI at particular stages in the life cycle of a

product they have pioneered
Firms invest in other advanced countries when local demand in those countries grows large enough to support local production, and then shift production to low-cost developing countries when product standardization and market saturation give rise to price competition and cost pressures
Vernon fails to explain why it is profitable for firms to undertake FDI rather than continuing to export from home base, or licensing a foreign firm

in addition to the various factors discussed earlier, it is

important to consider:
location-specific advantages - that arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets
and
externalities - knowledge spillovers that occur when companies in the same industry locate in the same area

a radical stance that is hostile to all FDI to

the non-interventionist principle of free market economies
Between these two extremes is an approach that might be called pragmatic nationalism

political and economic theory
It argues that the MNE is an

instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries

production should be distributed among countries according to the theory

of comparative advantage
The free market view has been embraced by a number of advanced and developing nations, including the United States, Britain, Chile, and Hong Kong

as inflows of capital, technology, skills and jobs, and costs,

such as repatriation of profits to the home country and a negative balance of payments effect
According to this view, FDI should be allowed only if the benefits outweigh the costs

the free
market stance creating:
a surge in FDI worldwide
an

increase in the volume of FDI in countries with newly liberalized regimes

a consideration of the costs and benefits of FDI

a host
country:
1. resource transfer effects - FDI can

make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available
2. employment effects - FDI can bring jobs to a host country that would otherwise not be created there

account is a record of a country’s payments to and

receipts from other countries.
The current account is a record of a country’s export and import of goods and services
Governments typically prefer to see a current account surplus than a deficit
FDI can help a country to achieve a current account surplus if the FDI is a substitute for imports of goods and services, and if the MNE uses a foreign subsidiary to export goods and services to other countries

in the form of greenfield investment increases the level of

competition in a market, driving down prices and improving the welfare of consumers
Increased competition can lead to increased productivity growth, product and process innovation, and greater economic growth

effects of FDI on competition within the host nation
subsidiaries

of foreign MNEs may have greater economic power than indigenous competitors because they may be part of a larger international organization

initial capital inflows that come with FDI must be the

subsequent outflow of capital as the foreign subsidiary repatriates earnings to its parent country
when a foreign subsidiary imports a substantial number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments

decisions that can affect the host country’s economy will be

made by a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control

effect on the capital account of the home country’s balance

of payments from the inward flow of foreign earnings
the employment effects that arise from outward FDI
the gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country

initial capital outflow required to finance the FDI
if the purpose

of the FDI is to serve the home market from a low cost labor location
if the FDI is a substitute for direct exports
Employment may also be negatively affected if the FDI is a substitute for domestic production

country concerns about the negative economic effects of offshore production

(FDI undertaken to serve the home market) may not be valid

various policies to regulate FDI

many nations now have government-backed insurance programs to cover major

types of foreign investment risk
To restrict outward FDI, most countries, including the United States, limit capital outflows, manipulate tax rules, or outright prohibit FDI

FDI, governments offer incentives to foreign firms to invest in

their countries
Incentives are motivated by a desire to gain from the resource-transfer and employment effects of FDI, and to capture FDI away from other potential host countries
To restrict inward FDI, governments use ownership restraints and performance requirements

was no consistent involvement by multinational institutions in the governing

of FDI
Today, the World Trade Organization is changing this by trying to establish a universal set of rules designed to promote the liberalization of FDI

for managers?
Managers need to consider what trade theory implies, and

the link between government policy and FDI

through the location-specific advantages argument associated with John Dunning
However, it

does not explain why FDI is preferable to exporting or licensing

variable in decisions about where to locate foreign production facilities

and where to make a foreign direct investment