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Foreign Direct Investment

1. Foreign direct investment (FDI) occurs when a firm invests directly in new facilities in a foreign country, making it a multinational enterprise. There are two main forms: greenfield investments and acquisitions. 2. Both the flow and stock of global FDI have increased over the last 20 years, with the US, EU, and Asian countries being top destinations. Services are becoming a larger portion of FDI. 3. Theories of FDI include that it allows firms more control over exports and avoids licensing drawbacks, while seeking advantages like access to markets or resources. Governments' political ideologies toward FDI range from hostile to non-interventionist.

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71 views18 pages

Foreign Direct Investment

1. Foreign direct investment (FDI) occurs when a firm invests directly in new facilities in a foreign country, making it a multinational enterprise. There are two main forms: greenfield investments and acquisitions. 2. Both the flow and stock of global FDI have increased over the last 20 years, with the US, EU, and Asian countries being top destinations. Services are becoming a larger portion of FDI. 3. Theories of FDI include that it allows firms more control over exports and avoids licensing drawbacks, while seeking advantages like access to markets or resources. Governments' political ideologies toward FDI range from hostile to non-interventionist.

Uploaded by

Krisel Jose
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 7

Foreign Direct
Investment
At the end of this module, you will be
able to:
1. Familiarize with current trends regarding foreign direct
investment in the world
economy.

2. Understand the different theories of FDI.

3. Appreciate how political ideology shapes a government’s


attitudes towards FDI.
Introduction

What is foreign direct investment?

• Foreign direct investment (FDI) occurs when a firm invests directly in new
facilities to produce and/or market in a foreign country
• Once a firm undertakes FDI it becomes a multinational enterprise
• There are two forms of FDI
– A greenfield investment
– Acquisition
The Form of FDI: Acquisitions
versus Greenfield Investments

• There are two forms of FDI


– A greenfield investment -the establishment of a wholly new
operation in a foreign country.

– Acquisition or merging with an existing firm in the foreign


country.
Foreign Direct Investment
in the World Economy

• There are two ways to look at FDI


– The flow of FDI refers to the amount of FDI undertaken over a
given time period
– The stock of FDI refers to the total accumulated value of
foreign-owned assets at a given time

• Outflows of FDI are the flows of FDI out of a country

• Inflows of FDI are the flows of FDI into a country


Trends in FDI
• Both the flow and stock of FDI in the world economy has increased over the
last 20 years
• FDI has grown more rapidly than world trade and world output because
– firms still fear the threat of protectionism
– the general shift toward democratic political institutions and free market
economies has encouraged FDI
– the globalization of the world economy is prompting firms to undertake FDI
to ensure they have a significant presence in many regions of the world
The Direction of FDI
•Historically, most FDI has been directed at the developed nations
of the world, with the United States being a favorite target
•FDI inflows have remained high during the early 2000s for the
United States, and also for the European Union •South, East, and
Southeast Asia, and particularly China, are now seeing an increase
of FDI inflows
•Latin America is also emerging as an important region for FDI
The Direction of FDI
• FDI can also be expressed as a percentage of gross fixed capital formation
summarizes (the total amount of capital invested in factories, stores, office
buildings, and the like)

• All else being equal, the greater the capital investment in an economy, the
more favorable its future prospects are likely to be

• So, FDI can be seen as an important source of capital investment and a


determinant of the future growth rate of an economy
The Source of FDI
• Since World War II, the U.S. has been the largest source
country for FDI

• Other important source countries include the United


Kingdom, the Netherlands, France, Germany, and Japan

• These countries also predominate in rankings of the world’s


largest multinationals
The Shift to Services
• In the last two decades, there has been a shift
towards FDI in services
• The shift to services is being driven by
– the general move in many developed countries toward services
– the fact that many services cannot be exported
– a liberalization of policies governing FDI in services
– the rise of Internet-based global telecommunications networks that
have allowed some service enterprises to relocate some of their value
creation activities to different nations to take advantage of favorable
factor costs
Theories of Foreign
Direct Investment

Why do firms prefer FDI to either exporting or


licensing?
Theories of Foreign Direct Investment

1. Limitations of Exporting

• The viability of an exporting strategy can be constrained by


transportation costs and trade barriers
2. Limitations of Licensing

• Internalization theory suggests that licensing has three major drawbacks


1. it may result in a firm’s giving away valuable technological know-
how to a potential foreign competitor
2. it does not give a firm the tight control over manufacturing,
marketing, and strategy in a foreign country that may be required to
maximize its profitability
3. It may be difficult if the firm’s competitive advantage is not
amendable to licensing
3. Advantages of Foreign Direct Investment

• A firm will favor FDI over exporting as an entry strategy when


– transportation costs are high
– trade barriers are high

• A firm will favor FDI over licensing when


– it wants control over its technological know-how
– it wants over its operations and business strategy
– the firm’s capabilities are not amenable to licensing
The Pattern of Foreign Direct Investment
• It is common for firms in the same industry to

1. have similar strategic behavior and undertake foreign direct investment around
the same time
2. direct their investment activities towards certain locations at certain stages in the
product life cycle
The Eclectic Paradigm
• John Dunning’s eclectic paradigm argues that in addition
to the various factors discussed earlier, two additional
factors must be considered when explaining both the
rationale for and the direction of foreign direct investment.

– location-specific advantages

– externalities
Political Ideology and
Foreign Direct Investment

• Ideology toward FDI has ranged from a radical stance


that is hostile to all FDI to the non-interventionist
principle of free market economies

• Between these two extremes is an approach that might


be called pragmatic nationalism
Shifting Ideology
• In recent years, there has been a strong shift toward the
free market stance creating

– a surge in the volume of FDI worldwide


– an increase in the volume of FDI directed at countries
that have recently liberalized their regimes

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