Transcript Chapter 4: Foreign Direct Investment: Practice and Theory Geographic trends The Trojan Horse? FDI Outward stock Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a International Trade and Investment.

Chapter 4: Foreign Direct Investment:
Practice and Theory
Geographic
trends
The Trojan
Horse?
FDI Outward stock
Copyright ©2003 McGraw-Hill Australia Pty Ltd PPTs t/a
International Trade and Investment by John Gionea
Slides prepared by John Gionea
1
TOPIC PLAN:


Determinants of Foreign Direct Investment(FDI)
FDI Concepts
» FDI Outflows/FDI Inflows
» Outward & Inward FDI Stock
» Mergers and Acquisitions


Sectoral Distribution of FDI
Theories of FDI: Global Horizons; The
International Product Cycle; Internalisation
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Foreign Direct Investment (FDI)

An investment involving management control
of a resident entity in one economy (THE
HOST COUNTRY), by an enterprise in
another economy (THE HOME COUNTRY).

FDI involves a long-term relationship
reflecting an investor’s lasting interest in a
foreign entity. The investor=The PARENT
firm and the foreign entity/asset= the
“affiliate” (“subsidiary”)
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Average annual growth rate,World FDI
Outflows, Exports of Goods & Services, GDP
40
35
30
25
FDI Outflows
20
% p.a
15
Exports of G&S
GDP
10
5
0
1986-1990
1991-1995
1996-1999
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Flow vs. Stock of FDI
Flow: Amount of FDI over a period of
time (one year).
 Stock: Total accumulated value of
foreign owned assets at a given point in
time.

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Other FDI concepts




FDI FLOWS (Outflows, Inflows)
FDI Stock (Outward, Inward)
“Greenfield” investment = new investment made
up by setting up a new affiliate overseas
Cross border M&As (Mergers and Acquisitions)=
acquisition of more than 10% equity share of an
existing operation overseas.
»
»
Mergers=the combining of two or more firms
Acquisition/take-over of an existing operation
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M&As vs. Greenfield Investments
At the time of entry and in the short term
M&As may involve smaller benefits or
larger negative impacts from the perspective of
host-country development

»
»
»
»

financial resources do not always add to stock
Less likely to transfer new technologies and skills
does not generate employment (possible lay-offs)
can increase concentration and lessen competition
However, in the long term many differences
diminish or disappear
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M&As vs. Greenfield Investments
UNCTAD’s World Investment Report
2000 concludes that, under normal
circumstances, Greenfield FDI is more
useful, in terms of its developmental
impact, to host countries than crossborder M&As.
 However, under exceptional
circumstances (e.g. economic crisis)
cross-border M&As can play a useful role

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M&As vs. Greenfield Investments
UNCTAD’s World Investment Report
2000 concludes that, under normal
circumstances, Greenfield FDI is more
useful, in terms of its developmental
impact, to host countries than crossborder M&As.
 However, under exceptional
circumstances (e.g. economic crisis)
cross-border M&As can play a useful role

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Determinants of Foreign Direct Investment

Trade restrictions
(the “Trojan horse").

Cost/profitability factors

Investment climate

Marketing factors
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Trade restrictions
(the “Trojan horse").

Barriers to trade

Preference of local
customers for local products.
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Cost/profitability Factors
Cheaper production costs
(labour, materials)
 Cheaper infrastructure
(electricity, telecom)
 Lower rental costs (commercial, residential)
 Expected higher profits.
 Desire to be near source of supply.

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Investment Climate
 Government
attitude toward
foreign investment (e.g. incentives)
 Political stability
 Limitations on ownership
 Currency exchange regulations
 Stability of foreign exchange
 Tax structure
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Geographic Distribution of FDI
Outflows,1983-2000,% of total
Year
Developed
Countries
Share(%)
1983-1987 95
Developing
Countries
Share(%)
5
Central&
Eastern
Europe(%)
0.01
1988-1992 93
7
0.02
1998-2000 92.97
6.8
0.3
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The Top 10 sources of Outward FDI
in 2000, % of world total
3.3
Canada
Switzerlan
Japan
Netherlands
Belgium-Lux
Hong Kong
Germany
France
UK
20.8
US
0.0
5.0
10.0
15.0
20.0
25.0
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Geographic Distribution of FDI
Inflows,1981-2000,% of total world
Year
Developed
Countries
Share(%)
1981-1985 74
Developing
Countries
Share(%)
26.0
Central&
Eastern
Europe(%)
0.04
1988-1990 82.7
17.1
0.2
1998-2000 76.3
21.4
2.3
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Shares of leading 5 economies in
inward FDI stock in 1980,2000
25
20
15
% of world
10
5
0
US
U.K
Hong
Kong
German
y
BelgLux
1980
13.5
10.2
22.5
5.9
1.2
2000
19.6
7.6
7.4
7.3
5.9
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Sectoral Distribution of FDI Inward
Stock, 1988, 1999
Developing Countries
Developed Countries
Sector
1988 1999
Sector
1988 1999
Primary
13.7
Primary
10.3 5.7
5.4
Secondary 65.0 54.5
Secondary 39.4 36.4
Tertiary
Tertiary
20.7 37.3
Unspecified 6.8
2.8
46.9 55.5
Unspecified 3.4
2.4
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FDI benefits/costs to Host
countries

Benefits:
»
»
»
»
»
»

Capital
Technology
Management
Employment
Exports
Current Account(?)
Costs
» Adverse effects on competition
» Adverse effects on the Balance of Payments
» Concerns about national sovereignty
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FDI benefits to Home countries
Improves balance of payments
 Positive employment effects

» Export demand can create jobs.
Increased knowledge from operating in
a foreign environment.
 Benefits the consumer through better
products and lower prices.

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FDI costs to Home countries

Negative effect on Balance of Payments
» Initial capital outflow (offset by subsequent
inflows).
» Multinational Enterprise (MNE) uses foreign
subsidiary to sell back to home market.
» MNE uses foreign subsidiary as a substitute for
direct exports (loss of export earnings).

Potential “export” of jobs.
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FDI and International Trade
The relationship between trade and FDI in a
given product is characterised by a
sequential process of internationalisation,
e.g. trade to FDI or FDI to trade
 Subsidiaries source goods and services from
parent companies and can do exports from
the host country
 FDI is not only a source of capital but also of
new technology, managerial skills and
marketing networks.

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Exports of foreign affiliates as % of total
exports in the primary & secondary sector
-Various years45.1
Canada(1994)
22.3
US(1996)
21.1
Mexico(1993)
60.6
Singapore(1996)
51
Malysia(1994)
35.4
Hong Kong,China(1997)
40.9
China(1997)
0
10
20
30
40
50
60
70
% of total exports
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Foreign Direct Investment Theories
 The
Global Horizons Theory
 The
International Product Cycle
 The
Internalisation Theory
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The Global Horizons Theory

Internal forces :
» The influence of a high executive
» The need to market a new technology//product
» Finding use for old equipment.
» The observed need for a larger market.
» Mergers/Acquisitions (e.g.BHP-Utah International)

External forces
» Influence of customers
» Initiative of foreign government
» Foreign expansion of a competitor
» Dramatic event (e.g.formation of a free-trade area)

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Fig.4.4:International Product Cycle
production
Innovating country (e.g. US, Japan)
Exports
Q
u
a
n
t
i
t
y
1
2
3
4
5
Imports consumption
6
7
8
9
10
11
12
13
14
Other Industrial countries
15
Exports
Imports
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Developing Countries
Exports
Imports
1
2
3
4
New Product
5
6
7
8
9
Maturing Product
10
11
12
13
14
15
Standardized Product
Stages of Production Development
Time
The Internalisation Theory




Internalisation:The extension of ownership by a firm
to cover new markets,new sources of materials and
new stages of the production process.
Horizontal / vertical integration
MNE accomplishes an international transfer of
factors,services and goods more efficiently than
external markets
MNE-An institution designed to create and exploit
internal markets.
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