Foreign Direct Investment

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Foreign Direct Investment Foreign Direct Investment (FDI)(FDI)

Purchase of physical assets or significant amount of ownership of a company in another country 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 InflowsYearly FDI Inflows

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

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Reasons for FDI GrowthReasons for FDI Growth

Increasingglobalization

International mergersand acquisitions

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Value of Cross-Border M&AsValue of Cross-Border M&As

Source: Based on World Investment Report (Geneva, Switzerland: UNCTAD), various years.

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Worldwide FDI FlowsWorldwide FDI Flows

World FDI inflows

Developed (57%), developing (37%)

European Union: 30% of world FDI

Developing nations

China: 6.4% of world FDI

All of Africa: 5.2% of world FDI

82,000 multinationals

with810,000 affiliates

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International Product Life International Product Life CycleCycle

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 Market Imperfections (Internalization)(Internalization)

Trade barriers(e.g., tariffs)

Unique advantage(e.g., special

knowledge)

A company undertakes FDI to internalize a transaction that is made inefficient because of a market imperfection

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Eclectic TheoryEclectic Theory

A firm undertakes FDI when location, ownership, and internalization advantages combine to make a location appealing

Locationadvantage

(optimal location)

Ownershipadvantage(special asset)

Internalizationadvantage

(efficiency)

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Market PowerMarket Power

A firm undertakes FDI to establish a dominant presence in an industry

Vertical integrationExtends company’s activitiesinto stages of production that provide its inputs (backward integration) or absorb its out-puts (forward integration)

Market power= Greater profits

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Management Issues IManagement Issues I

Control Purchase-or-build

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Management Issues IIManagement Issues II

Productioncosts

Customerknowledge

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Management Issues IIIManagement Issues III

Following rivals

Following clients

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Balance of PaymentsBalance of Payments

Capital accountCapital accountCurrent accountCurrent account

National accounting system that records all payments to entities in other countries and all receipts coming into the nation

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 PaymentsU.S. Balance of Payments

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Host Intervention in FDIHost Intervention in FDI

Balance of Payments+

Balance of Payments+

FDI may generate exportsFDI may generate exports

Initial FDI boosts economyInitial FDI boosts economy

FDI may decrease importsFDI may decrease imports

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Host Intervention in FDIHost Intervention in FDI

Obtain resourcesand benefits

+

Obtain resourcesand benefits

+

Access technologyAccess technology

Access management skillsAccess management skills

Create employmentCreate employment

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Home Intervention in FDIHome Intervention in FDI

+ Improves competitiveness+ Offshore ‘sunset’ industries

– Remove national resources– Eliminate export markets– Eliminate domestic jobs

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Host Promotion MethodsHost Promotion Methods

Financial incentives■ Low or waived taxes■ Low-interest loans

Infrastructure benefits■ Better seaports, roads,

and telecom networks

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Host Restriction MethodsHost Restriction Methods

Ownership restrictions■ Prohibit investment in industries or businesses

Performance demands■ Local content requirements■ Export targets■ Technology transfers

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Home Promotion MethodsHome Promotion Methods

Insurance on assets abroad

Loans and loan guarantees

Tax breaks on profits earned abroad

Special tax treaties

Persuade other nations to accept FDI

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Home Restriction MethodsHome Restriction Methods

Higher taxes onforeign income

Sanctions that prohibit investing