Lecture International business - Chapter 7: Foreign direct investment
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7
Foreign Direct
Investment
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Chapter Objectives
•
Describe worldwide patterns of foreign direct investment
(FDI) and reasons for those patterns
•
Describe each of the theories that attempt to explain why
FDI occurs
•
Discuss the important management issues in the FDI
decision
•
Explain why governments intervene in the free flow of FDI
•
Discuss the policy instruments that governments use to
promote and restrict FDI
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Volkswagen
• Produces 8 million cars a year
• Modular production strategy
• Special protection in Germany
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Foreign Direct Investment (FDI)
Purchase of physical assets or
significant amount of ownership
of a company in another country
in order to gain some measure of
management control
By contrast, portfolio investment
does not involve obtaining a
degree of control in a company
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Yearly FDI Inflows
Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
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Reasons for FDI Growth
Increasing
globalization
International mergers
and acquisitions
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Value of CrossBorder M&As
Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.
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Worldwide FDI Flows
World FDI inflows
Developed (49%), developing (45%)
European Union: 28% of world FDI
82,000 multinationals
Developing nations
China and India attract most FDI
All of Africa: 2.8% of world FDI
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810,000 affiliates
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Discussion Question
What is the
difference between
foreign direct
investment and
portfolio
investment?
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Answer to Discussion Question
Foreign direct investment is the
purchase of physical assets or a
significant amount of the
ownership of a company in
another country to gain a
measure of management
control.
Portfolio investment does not
involve obtaining a degree of
control in a company.
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International Product Life Cycle
A company begins by exporting its product and later undertakes
foreign direct investment as a product moves through its life
cycle
Source: Raymond Vernon and Louis T. Wells, Jr., The Economic Environment of International Business, 5th ed. (Upper Saddle River, N.J.: Prentice Hall, 1991), p.
85.
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Market Imperfections
(Internalization)
A company undertakes FDI to
internalize a transaction that
is made inefficient because of
a market imperfection
Trade barriers
(e.g., tariffs)
Unique advantage
(e.g., special knowledge)
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Eclectic Theory
FDI when location, ownership, and internalization
advantages combine to make a location appealing
Location
advantage
Ownership
advantage
Internalization
advantage
(optimal location)
(special asset)
(efficiency)
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Market Power
FDI used to establish a dominant presence in an industry
Market power
= Greater profits
Vertical integration
Extends company’s activities
into stages of production that
provide its inputs (backward
integration) or absorb its out
puts (forward integration)
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Discussion Question
The eclectic theory says
that firms undertake FDI
when location, ownership,
and __________
advantages combine to
make a location appealing
for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Answer to Discussion Question
The eclectic theory says
that firms undertake FDI
when location, ownership,
and __________
advantages combine to
make a location appealing
for investment.
a. Internalization
b. First-mover
c. Life-cycle
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Management Issues I
Control
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Purchase-or-build
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Management Issues II
Production
costs
Customer
knowledge
Source: LIU JIN/Newscom
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Management Issues III
Following clients
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Following rivals
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Balance of Payments
National accounting system that records all payments to entities
in other countries and all receipts coming into the nation
Current account
Capital account
The import and export of
goods and services,
income receipts on
assets abroad, and
income payments on
foreign assets inside the
country
The purchase or sale of
assets (including assets
such as property and
shares of common stock
in a company)
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U.S. Balance of Payments
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Discussion Question
What do we mean
by a country’s
balance of
payments and
what is its
usefulness?
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Answer to Discussion Question
A country’s balance of payments is
a national accounting system that
records all payments to entities in
other countries and all receipts
coming into the nation.
The system helps monitor a
country’s flows of goods, services,
income, and asset transfers
between itself and other nations.
The balance of payments position
sends warning signals about trade
deficits with other nations.
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Host Intervention I
Initial FDI boosts economy
Balance of Payments
+
FDI may decrease imports
FDI may generate exports
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Host Intervention II
Access technology
Obtain resources
and benefits
Access management skills
+
Create employment
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