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CHAPTER VIIFOREIGN DIRECT INVESTMENT

INTERNATIONAL BUSINESS

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Learning ObjectivesDescribe the worldwide patterns of foreign direct investment

(FDI) and the reasons for these patterns.

Describe each of the theories that attempt to explain why

foreign direct investment occurs.

Discuss the important management issues in the foreign

direct investment decision.

Explain why governments intervene in the free flow of

foreign direct investment.

Discuss the policy instruments that governments use to

promote and restrict foreign direct investment.

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FOREIGN DIRECT INVESTMENT

The purchase of physical

assets or a significant

amount of the ownership

(stock) of a company in

another country to gain a

measure of management

control.

PORTFOLIO INVESTMENT

Investment that does

not involve obtaining a

degree of control in a

company.

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I. PATTERNS OF FOREIGN DIRECT INVESTMENT

Ups and Downs of Foreign Direct Investment

Worldwide Flows of FDI

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1.1 Ups and Downs of Foreign Direct Investment (FDI)

Globalization

Mergers and Acquisitions

Role of Entrepreneurs and Small Businesses

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1.1.1 Ups and Downs of Foreign Direct Investment (FDI)

Globalization

Companies were trying to export their products to markets around the

world Wave of FDI

Another wave of FDI flows into low-cost newly industrialized &

emerging nations worldwide.

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1.1.2 Ups and Downs of Foreign Direct Investment (FDI)

Mergers and Acquisitions

The number of Mergers and Acquisitions and their

exploding values also underlie long-term growth in

FDI

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Mergers and Acquisitions

Many cross-border merger and acquisitions deals are driven by the

desire of companies to do any or all of the following:

– Get a foothold in a new geographic market

– Increase a firm’s global competitiveness

– Fill gaps in companies’ product lines in a global industry

– Reduce costs in areas such as research and development,

production, or distribution

1.1.2 Ups and Down of Foreign Direct Investment

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Role of Entrepreneurs and Small

Businesses

these companies are engaged in FDI

1.1.3 Ups and Down of Foreign Direct Investment

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Developed countries account for around

70%

Developing countries account for 30%

1.2 Worldwide Flows of FDI

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II. EXPLAINATIONS FOR FOREIGN DIRECT INVESTMENT

International Product Life Cycle

Market Imperfections (Internalization)

Eclectic Theory

Market Power

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International Product Life Cycle

Theory stating that a company will begin by

exporting its product and later undertake

foreign direct investment as a product

moves through its life cycle

II.1 International Product Life Cycle

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Market Imperfection (internalization)

Theory stating that when an imperfection in the market

makes a transaction less efficient than it could be, a

company will undertake foreign direct investment to

internalize the transaction and thereby remove the

imperfection

II.2 Market Imperfection (Internalization)

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Trade Barriers

One common market imperfection in international

business, such as Tariffs

Specialized Knowledge

The unique competitive advantage of company

sometimes consists of Specialized Knowledge

II.2 Market Imperfection (Internalization)

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Eclectic theory

Theory stating that firms undertake foreign direct

investment when the features of a particular

location combine with ownership and

internalization advantages to make a location

appealing for investment

II.3 Eclectic theory

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Market power

Theory stating that a firm tries to establish a

dominant market presence in an industry by

undertaking foreign direct investment

II.5 Market power

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II.5 Market power

Vertical integration

Extension of company activities into stages of

production that provide a firm’s inputs

( backward integration ) or absorb its output

( forward integration )

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III. MANAGEMENT ISSUES IN THE FDI DECISION

Control

Purchase- or- Build Decision

Production Costs

Customer Knowledge

Following Clients

Following Rivals

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III.1 Control

Control

Partnership Requirements

Benefits of Cooperation

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III.1.1 Partnership Requirements

Partnership Requirements

Because of the importance of control

Many companies have strict policies regarding

how

much ownership they will take in firms in other

nations

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III.1.2 Benefits of Cooperation

Benefits of Cooperation

Have seen greater harmony between governments

and international companies

Governments of many developing and newly

industrialized countries have come to realize the

benefits of investment by multinationals.

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III.2 Purchase-or- Build Decision

Whether to purchase an existing business

or to build a subsidiary abroad from the

ground up- call a greenfield investment.

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III.3 Production costs

Rationalized Production

System of production in which each of a

product’s components is produced where

the cost of producing that component is

lowest

Cost of Research and development

lead multinationals to engage in cross-

border alliances and acquisitions.

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III.4 Customer Knowledge

The behavior of buyers is an important issue

in the decision of whether to undertake FDI

A local presence can help companies gain

valuable knowledge about customers that

could not be obtained in the home market.

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III.5 Following Clients

Firms engage in FDI when doing so puts them

close to firms for which they act as a suppliers

This practice of “following clients” can be

expected in industries in which many component

parts are obtained from suppliers with whom a

manufacturer has a close working relationship.

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III.6 Following Rivals

Many firms believe that choosing not to

make a move parallel to that of the

“first mover” might result in being shut

out of a potentially lucrative market.

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IV. GOVERNMENT INTERVENTION IN FDI

Balance of Payments

Reasons for intervention by the host country

Reasons for intervention by the home country

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Balance of Payments

A national accounting systems that

records all payments to entities in other

countries and all receipts coming into the

nation

IV.1 Balance of Payments

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Current account

National account that records

transactions involving the import and

export of goods and services, income

receipt on assets abroad, and income

payment on foreign assets inside the

country

IV.1 Balance of Payments

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Current account surplus

When a country exports more goods and

services and receives more income from

abroad than it imports and pays abroad

IV.1 Balance of Payments

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Current account deficit

When a country imports more goods

and services and pays more abroad

than it exports and receives from

abroad

IV.1 Balance of Payments

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Capital account

A national account that records

transactions involving the purchase or

sale of assets

IV.1 Balance of Payments

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IV.2 Reasons for Intervention by the Host Country

Balance of Payments FDI inflows are recorded as additions to the

balance of payments Local production Exports host country’s balance of payment

Obtain Resources and Benefits Access to technology Management skills and employment.

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Investing in other nations sends

resources out of the home country

Outgoing FDI may ultimately damage a

nation’s Balance of Payments by taking

the place of its exports

Jobs resulting from outgoing

investments may replace jobs at home

IV.3 Reasons for Intervention by the Home Country

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Outward FDI can increase long term

competitiveness

Nations may encourage FDI in industries

that they have determined to be

“sunset” industries.

IV.3 Reasons for Intervention by the Home Country…

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V. GOVERNMENT POLICY INSTRUMENTS & FDI

Host Countries: Restriction

Host Countries: Promotion

Home Countries: Restriction

Home Countries: Promotion

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V.1 Host Countries: Restriction

Host countries have a variety of methods to

restrict incoming FDI

Ownership restriction

Performance demands

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V.1 Host Countries: Restriction

Ownership restriction

Government can impose ownership restrictions that

prohibit nondomestic companies from investing in

certain industries.

Performance demands

Influence how international companies operate in the

host nation

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V.2 Host Countries: Promotion

Financial incentive

Lower tax rates

Offers to waive taxes on local profits for a period of

time extending as far out as five years or more

Infrastructure improvements

Better seaports suitable, improved roads, increased

telecommunications systems.

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V.3 Home Countries: Restriction

Impose differential tax rates

That charge income from earning abroad at a higher

rate than domestic earning

Impose outright sanctions

That prohibit domestic firms from making

investment in certain nations.

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V.4 Home Countries: Promotion

Offer insurance to cover the risks of investment abroad

Grant loans to firms wishing to increase their investment abroad

Offer tax breaks on profits earned abroad or negotiate special

tax treaties

Apply political pressure on other nations to get them to relax

their restrictions on inbound investment.

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THE END