Chapter 6

Investing Abroad Directly

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

1. understand the vocabulary associated with foreign direct investment (FDI)

2. use the resource- and institution-based views to explain why FDI takes place

3. understand how FDI results in ownership, location, and internalization (OLI) advantages

4. identify different political views on FDI based on an understanding of FDI’s benefits and costs to host and home countries

5. participate in two leading debates on FDI

6. draw implications for action

THE FDI VOCABULARY

foreign direct investment (FDI) - Investments in activities that control and manage value creation in other countries

multinational enterprise (MNE) - A firm that engages in foreign direct investment

THE FDI VOCABULARY

foreign portfolio investment (FPI) - Investment in a portfolio of foreign securities such as stocks and bonds that do not entail the active management of foreign assets

management control rights - The rights to appoint key managers and establish control mechanisms

THE FDI VOCABULARY

FDI is direct - requires significant equity ownership and provides the combination of equity ownership rights and management control rights

significant ownership rights provide much needed management control rights

FPI represents essentially insignificant ownership rights and no management control rights

To compete successfully, firms need to deploy overwhelming resources and capabilities to overcome their liabilities of foreignness; FDI provides one of the best ways to facilitate extension of firm-specific resources and capabilities abroad

THE FDI VOCABULARY

horizontal FDI - A type of FDI in which a firm duplicates its home country-based activities at the same value chain stage in a host country

vertical FDI - A type of FDI in which a firm moves upstream or downstream in different value chain stages in a host country

THE FDI VOCABULARY

upstream vertical FDI - A type of vertical FDI in which a firm engages in different stages of the value chain in two different countries

downstream vertical FDI - The amount of FDI moving in a given period (usually a year) in a certain direction

THE FDI VOCABULARY

FDI flow - The amount of FDI moving in a given period (usually a year) in a certain direction

FDI inflow - Refers to inbound FDI moving into a country in a year

FDI outflow - Refers to outbound FDI movingout of a country in a year

FDI stock - The total accumulation of inbound FDI in a country or outbound FDI from a country

OLI Advantages

A firm’s quest for ownership (O) advantages, location (L) advantages, and internalization (I) advantages:

Ownership - Refers to MNEs’ possession and leveraging of certain valuable, rare, hard-to-imitate, and organizationally embedded (VRIO) assets overseas in the context of FDI

Location - Refers to advantages enjoyed by firms operating in certain areas

Internalization - Refers to the replacement of cross-border markets (such as exporting and importing) with one firm (the MNE) locating in two or more countries

OWNERSHIP ADVANTAGES

dissemination risks - risks associated with unauthorized diffusion of firm-specific know-how

LOCATION ADVANTAGES

agglomeration - location advantages that arise from the clustering of economic activities in certain locations

knowledge spillovers - Knowledge diffused from one firm to others among closely located firms that attempt to hire individuals from competitors

INTERNALIZATION ADVANTAGES

international transaction costs - tend to be higher than domestic costs - laws and regulations are typically enforced on a nation-state basis

intrafirm trade - international trade between two subsidiaries in two countries controlled by the same MNE

REALITIES OF FDI – POLITICAL VIEWS

radical view - political view that is hostile to FDI

free market view - political view that suggests that FDI, unrestricted by government intervention, will enablecountries to tap into their absolute or comparative advantages by specializing in the production of certain goods and services

pragmatic nationalism - political view that approves FDI only when its benefits outweigh its costs

Benefits and Costs of FDI to Host Countries

technology spillovers - foreign technology

diffused domestically that benefits domestic firms and industries

demonstration effect (contagion or imitation effect) - reaction of local firms to technology spillovers

Benefits and Costs of FDI to Home Countries

Repatriated earnings of profits from FDI

Increased exports of components and services to host countries

Learning via FDI from operations abroad

HOW MNEs AND HOST GOVERNMENTS BARGAIN

obsolescing bargain - deal struck by MNEs and host governments, which change their requirements after initial FDI entry

expropriation - Government’s tactics that include removing incentives, demanding a higher share of profits and taxes, and confiscating foreign assets

sunk costs - point at which a firm has invested substantial sums of resources

FDI versus Outsourcing

A strategic debate is whether FDI (captive sourcing) or outsourcing will serve firms’ purposes better?

Facilitating versus Confronting Inbound FDI

Can foreigners and foreign firms be trusted in making decisions important to the local economy?