Chapter 7 - FDI (1)

CHAPTER 7

FOREIGN DIRECT INVESTMENT (FDI)

• WORLDWIDE PATTERN OF FDI

• SUMMARY OF THEORY OF FDI EXPLANATION

• IMPORTANT MANAGEMENT ISSUES IN FDI DECISION

• REASONS GOVERNMENT INTERVENE IN FDI

• POLICY INSTRUMENT GOVERNMENTS USE TO PROMOTE AND RESTRICT FDI

LEARNING OBJECTIVES

WORLDWIDE PATTERN OF FDI

• Volkswagen Group (www.vw.com) 48 production facilities worldwide Sells to more than 150 countries Top-selling manufacturer in South America and China China accounts for around 30% of VW’s total sales

• VW’s U.S. expansion

• Modular strategy

• Special protection in Germany

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VW in Portugal assembly plant

http://www.vw.com/

FOREIGN DIRECT INVESTMENT

Foreign Direct Investment

• 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


PATTERN OF FOREIGN DIRECT INVESTMENT


Drivers of FDI Flows

Globalization

Mergers and Acquisitions


DRIVERS OF FDI FLOWS


VALUE OF CROSS-BORDER MERGERS AND ACQUISITIONS

• Driving FDI growth are more than 100,000 multinational companies with more than 900,000 affiliates abroad.

• In 2012, developing countries attracted greater FDI inflows than did developed countries.

• Developed countries account for 42 percent ($561 billion) of total global FDI inflows.

• FDI inflows to developing countries accounted for around 52 percent of world FDI inflows ($703 billion).

WORLDWIDE FLOWS OF FDI



QUICK STUDY 1

• The purchase of physical assets or significant ownership of a company abroad to gain a measure of management control is called a what?

• What are the main drivers of foreign direct investment flows?

• Why might a company engage in a cross-border merger or acquisition?

SUMMARY OF THEORY OF FDI EXPLANATION


1. International Product Life Cycle

2. Market Imperfections (Internalization)

3. Eclectic Theory

4. Market Power

New Product StageMaturing Product

StageStandardized Product Stage



1. International Product Life Cyclestates that a company begins by exporting its product and then later undertakes FDI as a product moves through its life cycle.

MARKET IMPERFECTIONS

Trade Barriers

Specialized Knowledge


2. Market Imperfections (Internalization)states that when an imperfection in the market makes a transaction less efficient than it could be, a company will undertake FDI to internalize the transaction and thereby remove the imperfection.


Eclectic Theory

Location Advantage

Ownership Advantage

Internalization Advantage


3. Eclectic Theorystates that firms undertake foreign direct investment when the features of a location combine with ownership and internalization advantages to make a location appealing for investment.


Vertical Integration

• Backward Integration

• Forward Integration

Market Power


4. Market Power states that a firm tries to establish a dominant market presence in an industry by undertaking FDI.


QUICK STUDY 2


• What imperfections are relevant to the discussion of market imperfections theory?

• Location, ownership, and internalization advantages combine in which FDI theory?

• Which FDI theory depicts a firm establishing a dominant market presence in an industry?

• Control• Purchase-or-Build Decision• Production Costs

– Rationalized production– Mexico’s Maquiladora– Cost of research and

development

• Customer Knowledge• Following Clients• Following Rivals

IMPORTANT MANAGEMENT ISSUES IN FDI DECISION


• Control– Partnership Requirement– Benefits of Cooperation

• http://www.moneycontrol.com/news/business/executive-order-needed-to-solve-fdi-insurance-issue-ey_1643561.html


• Purchase-or-Build Decision– Greenfield investment – Acquisition or build subsidiary

– http://www.investopedia.com/video/play/green-field-investment/

– Cost of research and development

• Powerful competitive advantage

• Conducted by affiliates in other countries


• Production Costs

– Rationalized production• Component production• Assembly plant

– Mexico’s Maquiladora• Special economic region• Low-wage economy• Split by wage or technology gaps

Balance of Payments

REASONS GOVERNMENT INTERVENE IN FDI

Balance of Payments

Current Account

National account that records transactions

involving the export and import of goods

and services, income receipts on assets abroad, and income payments on foreign assets inside the country

Capital Account

National account that records transactions involving the

purchase and sale of assets


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

paymentObtain Resources and

Benefits

Access to technology

Management skills and employment.


Reasons for Intervention by

the Home Country

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

Outward FDI can increase long term competitivenessNations may

encourage FDI in industries that they

have determined to be “sunset” industries.


Host Countries: Restriction

Host Countries: Promotion

Home Countries: Restriction

Home Countries: Promotion

POLICY INSTRUMENT GOVERNMENTS USE TO PROMOTE AND RESTRICT FDI

• 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.

Host countries have a variety of methods

to promote incoming FDI

• 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

Host countries have a variety of methods to restrict incoming

FDI


Home countries have a variety of methods to restrict incoming FDI• 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.

Home countries have a variety of methods to promote incoming FDI• 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.


Chapter 7(FDI)

PatternTheories

Management issues

Government Intervention

Policy Instruments

Globalization

Mergers & Acquisitions

Ups & down of FDI

Worldwide flows of FDI

International Product Life Cycle

Market Imperfections (Internalization)

Eclectic Theory

Market Power

• Trade Barriers• Specialized Knowledge

Control

Production Costs

Customer Knowledge

Following Clients

Following Rivals

• Partnership Requirements• Benefits of Cooperation

Purchase-or-Build Decision

• Rationalized Production• Mexico’s Maquiladora• Cost of Research and

Development

Reasons for Intervention by the Host Country

Balance of Payments

Reasons for Intervention by the Home Country

• Current Account

• Capitol Account

• Control Balance of payments

• Obtain Resources & Benefits

Host Countries

Home Countries

Promotion• Financial Incentives• Infrastructure

Improvements

Restriction• Ownership Restriction• Performance

Demands

• Promotion• Restriction

Documents

Chapter 7 - FDI (1)