mba 531 week 3 - overview - chap 08 - 09

MBA 531Business in Today’s Global

Environment

Overview of Week 3 Textbook Readings: Chapters 8 and 9

Chapter 8

Foreign Direct Investment

8-3

What Is FDI?Foreign direct investment (FDI) occurs

when a firm invests directly in new facilities to produce and/or market in a foreign country the firm becomes a multinational enterprise

FDI can be in the form of greenfield investments - the establishment of

a wholly new operation in a foreign country acquisitions or mergers with existing firms in

the foreign country

8-4

What Is FDI?

The flow of FDI - the amount of FDI undertaken over a given time period Outflows of FDI are the flows of FDI out of a

country Inflows of FDI are the flows of FDI into a

countryThe stock of FDI - the total accumulated

value of foreign-owned assets at a given time

8-5

What Are The Patterns Of FDI?

Both the flow and stock of FDI have increased over the last 35 years Most FDI is still targeted towards developed

nations United States, Japan, and the EU

but, other destinations are emerging South, East, and South East Asia

especially China Latin America

8-6

What Are The Patterns Of FDI?FDI Outflows 1982-2012 ($ billions)

8-7

What Are The Patterns Of FDI?FDI Inflows by Region 1995-2011 ($ billion)

8-8

What Are The Patterns Of FDI? The growth of FDI is a result of

1. a fear of protectionism want to circumvent trade barriers

2. political and economic changes deregulation, privatization, fewer restrictions on

FDI3. new bilateral investment treaties

designed to facilitate investment 4. the globalization of the world economy

many companies now view the world as their market

need to be closer to their customers

8-9

What Are The Patterns Of FDI?

Gross fixed capital formation - the total amount of capital invested in factories, stores, office buildings, and the like the greater the capital investment in an

economy, the more favorable its future prospects are likely to be

So, FDI is an important source of capital investment and a determinant of the future growth rate of an economy

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What Are The Patterns Of FDI?Inward FDI as a % of Gross Fixed Capital Formation 1992-2008

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What Is The Source Of FDI?

Since World War II, the U.S. has been the largest source country for FDI the United Kingdom, the Netherlands, France,

Germany, and Japan are other important source countries

together, these countries account for 60% of all FDI outflows from 1998-2011

8-12

What Is The Source Of FDI?Cumulative FDI Outflows 1998-2011 ($ billions)

8-13

Why Do Firms Choose Acquisition Versus Greenfield Investments?

Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments between 40-80% of all FDI inflows per annum

from 1998 to 2011 were in the form of mergers and acquisitions but in developing countries two-thirds of

FDI is greenfield investment fewer target companies

8-14

Why Do Firms Choose Acquisition Versus Greenfield Investments?

Firms prefer to acquire existing assets because mergers and acquisitions are quicker to

execute than greenfield investments it is easier and perhaps less risky for a firm to

acquire desired assets than build them from the ground up

firms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

8-15

Why Choose FDI? Question: Why does FDI occur instead of

exporting or licensing?1. Exporting - producing goods at home

and then shipping them to the receiving country for sale

exports can be limited by transportation costs and trade barriers

FDI may be a response to actual or threatened trade barriers such as import tariffs or quotas

8-16

Why Choose FDI?2. Licensing - granting a foreign entity the right to

produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells

Internalization theory (aka market imperfections theory) - compared to FDI licensing is less attractive

firm could give away valuable technological know-how to a potential foreign competitor

does not give a firm the control over manufacturing, marketing, and strategy in the foreign country

the firm’s competitive advantage may be based on its management, marketing, and manufacturing capabilities

8-17

What Is The Pattern Of FDI? Question: Why do firms in the same industry

undertake FDI at about the same time and the same locations?

Knickerbocker - FDI flows are a reflection of strategic rivalry between firms in the global marketplace multipoint competition -when two or more enterprises

encounter each other in different regional markets, national markets, or industries

8-18

What Is The Pattern Of FDI? Question: But, why is it profitable for firms to

undertake FDI rather than continuing to export from home base, or licensing a foreign firm?

Dunning’s eclectic paradigm - it is important to consider location-specific advantages - that arise from using

resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets

externalities - knowledge spillovers that occur when companies in the same industry locate in the same area

8-19

What Are The Theoretical Approaches To FDI?

The radical view - the MNE is an instrument of imperialist domination and a tool for exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries in retreat almost everywhere

The free market view - international production should be distributed among countries according to the theory of comparative advantage embraced by advanced and developing nations

including the United States and Britain, but no country has adopted it in its purest form

8-20

What Are The Theoretical Approaches To FDI?

Pragmatic nationalism - FDI has both benefits (inflows of capital, technology, skills and jobs) and costs (repatriation of profits to the home country and a negative balance of payments effect) FDI should be allowed only if the benefits outweigh

the costs Recently, there has been a strong shift toward

the free market stance creating a surge in FDI worldwide an increase in the volume of FDI in countries with

newly liberalized regimes

8-21

How Does FDI Benefit The Host Country?

There are four main benefits of inward FDI for a host country

1. Resource transfer effects - FDI brings capital, technology, and management resources

2. Employment effects - FDI can bring jobs

8-22

How Does FDI Benefit The Host Country?

3. Balance of payments effects - FDI can help a country to achieve a current account surplus

4. Effects on competition and economic growth - greenfield investments increase the level of competition in a market, driving down prices and improving the welfare of consumers can lead to increased productivity growth, product

and process innovation, and greater economic growth

8-23

What Are The Costs Of FDI To The Host Country?

Inward FDI has three main costs:1. Adverse effects of FDI on competition

within the host nation subsidiaries of foreign MNEs may have

greater economic power than indigenous competitors because they may be part of a larger international organization

8-24

What Are The Costs Of FDI To The Host Country?

2. Adverse effects on the balance of payments when a foreign subsidiary imports a substantial

number of its inputs from abroad, there is a debit on the current account of the host country’s balance of payments

3. Perceived loss of national sovereignty and autonomy decisions that affect the host country will be made by

a foreign parent that has no real commitment to the host country, and over which the host country’s government has no real control

8-25

How Does FDI Benefit The Home Country?

The benefits of FDI for the home country include1. The effect on the capital account of the home

country’s balance of payments from the inward flow of foreign earnings

2. The employment effects that arise from outward FDI

3. The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country

8-26

What Are The Costs Of FDI To The Home Country?

1. The home-country’s balance of payments can suffer from the initial capital outflow required to

finance the FDI if the purpose of the FDI is to serve the home

market from a low cost labor location if the FDI is a substitute for direct exports

8-27

What Are The Costs Of FDI To The Home Country?

2. Employment may also be negatively affected if the FDI is a substitute for domestic production

But, international trade theory suggests that home-country concerns about the negative economic effects of offshore production (FDI undertaken to serve the home market) may not be valid

may stimulate economic growth and employment in the home country by freeing resources to specialize in activities where the home country has a comparative advantage

8-28

How Does Government Influence FDI?

Governments can encourage outward FDI government-backed insurance programs to

cover major types of foreign investment riskGovernments can restrict outward FDI

limit capital outflows, manipulate tax rules, or outright prohibit FDI

8-29

How Does Government Influence FDI?

Governments can encourage inward FDI offer incentives to foreign firms to invest in

their countries gain from the resource-transfer and employment

effects of FDI, and capture FDI away from other potential host countries

Governments can restrict inward FDI use ownership restraints and performance

requirements

8-30

How Do International Institutions Influence FDI?

Until the 1990s, there was no consistent involvement by multinational institutions in the governing of FDI

Today, the World Trade Organization is changing this by trying to establish a universal set of rules designed to promote the liberalization of FDI

8-31

What Does FDI Mean For Managers?

Managers need to consider what trade theory implies about FDI, and the link between government policy and FDI

The direction of FDI can be explained through the location-specific advantages argument associated with John Dunning however, it does not explain why FDI is

preferable to exporting or licensing, must consider internalization theory

8-32


A Decision Framework

8-33


A host government’s attitude toward FDI is important in decisions about where to locate foreign production facilities and where to make a foreign direct investment firms have the most bargaining power when

the host government values what the firm has to offer, when the firm has multiple comparable alternatives, and when the firm has a long time to complete negotiations

Chapter 9

Regional Economic Integration

8-35

What Is Regional Economic Integration?

Regional economic integration - agreements between countries in a geographic region to reduce tariff and non-tariff barriers to the free flow of goods, services, and factors of production between each other

Question: Do regional trade agreements promote free trade? In theory, yes, but the world may be moving toward a

situation in which a number of regional trade blocks compete against each other

8-36

What Are The Levels Of Regional Economic Integration?

1. A free trade area eliminates all barriers to the trade of goods and services among member countries European Free Trade Association (EFTA) -

Norway, Iceland, Liechtenstein, and Switzerland

North American Free Trade Agreement (NAFTA) - U.S., Canada, and Mexico

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2. A customs union eliminates trade barriers between member countries and adopts a common external trade policy Andean Community (Bolivia, Colombia, Ecuador,

and Peru) 3. A common market has no barriers to trade

between member countries, a common external trade policy, and the free movement of the factors of production Mercosur (Brazil, Argentina, Paraguay, and

Uruguay)

8-38


4. An economic union has the free flow of products and factors of production between members, a common external trade policy, a common currency, a harmonized tax rate, and a common monetary and fiscal policy European Union (EU)

5. A political union involves a central political apparatus that coordinates the economic, social, and foreign policy of member states the EU is headed toward at least partial political

union, and the U.S. is an example of even closer political union

8-39


Levels of Economic Integration

8-40

Why Should Countries Integrate Their Economies?

All countries gain from free trade and investment regional economic integration is an attempt to exploit

the gains from free trade and investment Linking countries together, making them more

dependent on each other creates incentives for political cooperation and

reduces the likelihood of violent conflict gives countries greater political clout when dealing

with other nations

8-41

What Limits Efforts At Integration?

Economic integration can be difficult because while a nation as a whole may benefit from a regional

free trade agreement, certain groups may lose it implies a loss of national sovereignty

Regional economic integration is only beneficial if the amount of trade it creates exceeds the amount it diverts trade creation occurs when low cost producers within

the free trade area replace high cost domestic producers

trade diversion occurs when higher cost suppliers within the free trade area replace lower cost external suppliers

8-42

What Is The Status Of Regional Economic Integration In Europe? Europe has two trade blocs 1. The European Union (EU) with 27

members2. The European Free Trade Area (EFTA)

with 4 members The EU is seen as the world’s next

economic and political superpower

8-43

What Is The Status Of Regional Economic Integration In Europe?

Member States of The European Union in 2012

8-44

What Is The European Union? The devastation of two world wars on Western

Europe prompted the formation of the EU Members wanted lasting peace and to hold their own

on the world’s political and economic stage Forerunner was the European Coal and Steel

Community (1951) The European Economic Community (1957) was

formed at the Treaty of Rome with the goal of becoming a common market

8-45

What Is The European Union? The Single European Act (1987)

committed the EC countries to work toward establishment of a single market by December 31, 1992

was born out of frustration among EC members that the community was not living up to its promise

provided the impetus for the restructuring of substantial sections of European industry allowing for faster economic growth than would otherwise have been the case

8-46

What Is The Political Structure

Of The European Union? The main institutions in the EU include: 1. The European Council - the ultimate controlling

authority within the EU2. The European Commission - responsible for proposing

EU legislation, implementing it, and monitoring compliance with EU laws by member states

3. The European Parliament - debates legislation proposed by the commission and forwarded to it by the council

4. The Court of Justice - the supreme appeals court for EU law

8-47

What Is The Euro?The Maastricht Treaty committed the EU

to adopt a single currency created the second largest currency zone in

the world after that of the U.S. dollar used by 17 of the 27 member states Britain, Denmark, and Sweden opted out

since its establishment January 1, 1999, the euro has had a volatile trading history with the U.S. dollar

8-48

Is The Euro A Good Thing? Benefits of the euro

savings from having to handle one currency, rather than many

it is easier to compare prices across Europe, so firms are forced to be more competitive

gives a strong boost to the development of highly liquid pan-European capital market

increases the range of investment options open both to individuals and institutions

Costs of the euro loss of control over national monetary policy EU is not an optimal currency area

8-49

Should The EU Continue To Expand?

Many countries have applied for EU membership

Ten countries joined in 2004 expanding the EU to 25 states

In 2007, Bulgaria and Romania joined bringing membership to 27 countries

Turkey has been denied full membership because of concerns over human rights

8-50

What Is The Status Of Economic Integration In The Americas?

There is a move toward greater regional economic integration in the Americas

The biggest effort is the North American Free Trade Area (NAFTA)

Other efforts include the Andean Community and Mercosur

A hemisphere-wide Free Trade of the Americas is under discussion

8-51

What Is The Status Of Economic Integration In The Americas?

Economic Integration in the Americas

8-52

What Is The North American Free Trade Agreement?

The North American Free Trade Area includes the United States, Canada, and Mexico abolished tariffs on 99% of the goods traded between

members removed barriers on the cross-border flow of services protects intellectual property rights removes most restrictions on FDI between members allows each country to apply its own environmental

standards establishes two commissions to impose fines and

remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored

8-53

Is The North American Free Trade Area Beneficial?

Supporters of NAFTA claimed that Mexico would benefit

from increased jobs as low cost production moves south and will see more rapid economic growth as a result

the U.S. and Canada would benefit from access to a large and increasingly prosperous market the lower prices for consumers from goods produced

in Mexico low cost labor and the ability to be more competitive

on world markets increased imports by Mexico

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Is The North American Free Trade Area Beneficial?

Critics of NAFTA claimed that jobs would be lost and wage levels would

decline in the U.S. and Canada pollution would increase due to Mexico's more

lax standards Mexico would lose its sovereignty

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Who Was Right?

Research indicates that NAFTA’s early impact was subtle, and both advocates and detractors may have been guilty of exaggeration

NAFTA is credited with helping create increased political stability in Mexico

Other Latin American countries would like to join NAFTA

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What Is The Andean Community?

The Andean Pact formed in 1969 using the EU model had more or less failed by the mid-1980s was re-launched in 1990, and now operates

as a customs union renamed the Andean Community in 1997 signed an agreement in 2003 with Mercosur

to restart negotiations towards the creation of a free trade area

8-57

What Is Mercosur? Mercosur

originated in 1988 as a free trade pact between Brazil and Argentina

was expanded in 1990 to include Paraguay and Uruguay and in 2005 with the addition of Venezuela

may be diverting trade rather than creating trade, and local firms are investing in industries that are not competitive on a worldwide basis

initially made progress on reducing trade barriers between member states, but more recently efforts have stalled

8-58

What Is The Central American Trade Agreement And CARICOM? There are two other trade pacts in the Americas

the Central American Trade Agreement –(CAFTA, 2005) - to lower trade barriers between the U.S. and members

CARICOM (1973) - to establish a customs union Neither pact has achieved its goals yet In 2006, six CARICOM members formed the

Caribbean Single Market and Economy (CSME) - to lower trade barriers and harmonize macro-economic and monetary policy between members

8-59

What Is Free Trade Of The Americas?

Talks began in April 1998 to establish a Free Trade of The Americas (FTAA) by 2005

The FTAA was not established and now support from the U.S. and Brazil is mixed the U.S. wants stricter enforcement if intellectual

property rights Brazil and Argentina want the U.S. to eliminate

agricultural subsidies and tariffs If the FTAA is established, it will have major implications

for cross-border trade and investment flows within the hemisphere would create a free trade area of 850 million people

who accounted for nearly $18 trillion in GDP in 2008

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What Is The Status Of Economic Integration In Asia?Various efforts at integration have been

attempted in Asia, but most exist in name only Association of Southeast Asian Nations

(ASEAN) Asia-Pacific Economic Cooperation (APEC)

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What Is The Association Of Southeast Asian Nations?

The Association of Southeast Asian Nations (ASEAN, 1967) currently includes Brunei, Indonesia, Malaysia, the

Philippines, Singapore, Thailand, Vietnam, Myanmar, Laos, and Cambodia

wants to foster freer trade between member countries and to achieve some cooperation in their industrial policies

An ASEAN Free Trade Area (AFTA) between the six original members of ASEAN came into effect in 2003 ASEAN and AFTA are moving towards establishing a

free trade zone

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What Is The Association Of Southeast Asian Nations?

ASEAN Countries

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What Is The Asia-Pacific Economic Cooperation?

The Asia-Pacific Economic Cooperation (APEC) has 21 members including the United States,

Japan, and China wants to increase multilateral cooperation member states account for 55% of world’s

GNP, and 49% of world trade

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What Is The Asia-Pacific Economic Cooperation?

APEC Members

8-65

What Is The Status Of Economic Integration In Africa?

Many countries are members of more than one of the nine blocs in the region but, since many countries support the use of

trade barriers to protect their economies from foreign competition, meaningful progress is slow

The East African Community (EAC) was re-launched in 2001, however so far, the effort appears futile

8-66

What Does Economic Integration Mean For Managers?

Regional economic integration opens new markets allows firms to realize cost economies by centralizing

production in those locations where the mix of factor costs and skills is optimal

But within each grouping, the business environment

becomes competitive there is a risk of being shut out of the single market

by the creation of a “trade fortress”

mba 531 week 3 - overview - chap 08 - 09

Education