6-1

CHAPTER 7

Foreign Direct
Investment

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 6-2

Chapter Focus

This chapter seeks to identify the economic

rationale that underlies Foreign Direct
Investment. For example, why do some
firms prefer FDI to exporting or licensing. Is
the need for control, part of the answer?

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 6-3

Foreign Direct Investment

• FDI occurs when a firm invests directly in facilities to
produce and/or market a product in a foreign country.
• Once a firm undertakes FDI, it becomes a
multinational enterprise (multinational = more than
one country).
• FDI takes two forms:
• Greed-field investment: establishing a wholly new
operation in a foreign country.
• Acquiring or merging with an existing firm in the
foreign country.
• Investing in foreign financial instruments (Portfolio
Investment) IS NOT FDI.

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 6-4

Flow and Stock of FDI

• Flow: • Stock:
• The amount of FDI • Total accumulated
undertaken over a value of foreign-
given period of time owned assets at a
(usually one year). given time.

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 6-5

FDI Outflows
1982-2000

1400
1200
1000
800
600 $ Billions
400
200
0
82- 92 94 96 98 2000 Figure 6.1
86

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 6-6

FDI Flows by Region

600
500
400
Index

Value Exports
300 World GDP
200 World FDI

100
0

Figure 6.2

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 6-7

Reasons for FDI Growth

•FDI circumvents potential future trade

barriers.
•Dramatic political and economic changes
occurring in developing countries.
•Globalization of the world economy
has raised the vision of firms who now
see the entire world as their market
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 6-8

Increase in the Number of Bilateral Trade

Treaties

2000
1800
1600
1400
1200
Treaties
1000
Countries
800
600
400
200
0
1993 1995 1998 1999 2000

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 6-9

Reasons for FDI Growth

• Historically, most FDI has been directed at the
developed nations of the world as firms based in
advanced countries invested in other markets
• The US has been the favorite target for FDI inflows

• While developed nations still account for the largest

share of FDI inflows, FDI into developing nations has
increased

• Most recent inflows into developing nations have

been targeted at the emerging economies of South,
East, and Southeast Asia
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 6-10

FDI into Developed and Developing Nations:

1990-2000

1200

1000 Dev Nations

800 Devg. Nations

$Billion

W. Europe
600
N. Amer.
400
Asia
200 L. Amer.

0
94 95 96 97 98 99 2000 Figure 6.3

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 6-11

The Form of FDI:

Acquisitions versus Greed-Fields
• The majority of • Why the preference for
investments is in the form mergers & acquisitions?
of mergers & acquisitions: • Quicker to execute.
• Represents about 77% of • Foreign firms have valuable
all flows in developed strategic assets.
countries. • Believe they can increase
• Represent about 33% of all the efficiency of the
flows in developing acquired firm.
countries.
• Fewer target firms.

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 6-12

FDI and Risk

FDI is expensive and risky compared

to exporting or
licensing:
Costs of establishing facilities.
Problems with doing business in a
different Culture.

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 6-13

Political Ideology and

Foreign Direct Investment

Radical Pragmatic Free

View Nationalism Market

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 6-14

Political Ideology & FDI

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 6-15

The Radical View

• Marxist view: MNE’s exploit less-
developed host countries
• Extract profits
• Give nothing of value in exchange
• Instrument of domination, not
development
• Keep less-developed countries relatively
backward and dependent on capitalist
nations for investment, jobs, and
technology

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 6-16

The Radical View

•By the end of the 1980s radical
view was in retreat
• Collapse of communism
• Bad economic performance of countries
that embraced the radical view
• Strong economic performance of
countries who embraced capitalism
rather than the radical view

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 6-17

The Free Market View

• Nations specialize in goods and services

that they can produce most efficiently
• Resource transfers benefit and strengthen
the host country
• Positive changes in laws and growth of
bilateral agreements attest to strength of
free market view
• All countries impose some restrictions on
FDI
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 6-18

The Free Market View

•Trinidad and Tobago, a recipient of

substantial FDI inflows in its natural
gas
•FDI inflows in its natural gas industry
for the last decade
•FDI-assisted development only occurs
when governments in less-developed
economies pursue credible, selective
intervention policies
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 6-19

Pragmatic Nationalism

• FDI has benefits and costs

• Allow FDI if benefits outweigh
costs
• Block FDI that harms indigenous
industry
• Court FDI that is in national interest
• Tax breaks
• Subsidies

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 6-20

Horizontal Direct Investment

Horizontal Direct Investment: FDI in the

same industry as the firm operates at
home. Factors to consider:

Transportation Costs.
Market Imperfections.
Strategic Competitors.
The Product Life Cycle
Location Advantages.

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 6-21

Horizontal FDI and Factor Considerations

Transportation Costs: High/low value to weight impacts

costs.
Market Imperfections (Internalization Theory): Factors
that inhibit markets from working perfectly. This
includes (1) governments impeding the free flow of
products between nations, and (2) impediments to
the sale of know-how.
Strategic Behavior: Concentrated industries (oligopoly) tend
to mimic each other’s moves. Where there is
multipoint competition, competing firms match each
other’s moves to keep the competitor in check.

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Horizontal FDI and Factor Considerations

The Product Life Cycle: Suggests that foreign market

demand leads to FDI, probably not true and
therefore is not a good predictor of FDI.

Location-Specific Advantages: Advantages that arise

from using resource endowments or assets tied
to a particular location

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 6-23

Vertical FDI

• Two forms:
• Backward: Providing inputs (raw materials,
parts) for a firm’s domestic production
processes.
• Forward: An industry abroad sells the outputs
of the firm’s domestic production processes.

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