Ch.

7: FDI’s

forms of FDI’s:

Greenfield investment: establishment of a wholly new operation in a foreign country

Mergers and acquisitions: acquisitions of, or mergers with, an existing firm in a foreign
country
Forms of Acquisitions:
➢ Minority: 10-49%
➢ Majority: 50-99%
➢ Full outright stake: 100%
Mergers & Acquisitions (M&As)
Most cross-border investments tend to be M&As rather than greenfield investments. Why
Mergers and Acquisitions?
➢ M&As tend to be quicker to execute than greenfield investments
➢ It is usually easier and more efficient to acquire assets than build them from the
ground up
➢ Firms believe they can increase the efficiency of acquired assets
by transferring capital, technology, or management skills

Flow vs Stock of FDI

The flow of FDI: The amount of FDI undertaken over a given period, usually a year.
The stock of FDI: The total accumulated value of foreign-owned assets at a given time.

Outflow of FDI: the flow of FDI out of a country

Since World War II, the U.S. has been the most important source country for FDI, a position it
retained during the late 1990s and throughout the 2000s.

inflow of FDI: the flow of FDI into a country

Historically, most FDI has been directed at developed nations worldwide, as firms based in
these countries invested in each other’s markets.
➢During the past few decades, the U.S. has been the favourite target of FDI inflows.
◦ The U.S. is the only country in the world with a population of over 330 million (as of
2020) and a comparatively high GDP per capita. In short, there are many American consumers
with significant spending power.

Patterns of FDI
Over the past 30 years, FDI has increased substantially.
Why?
➢ Firms fear the threat of protectionism and use FDI to overcome trade barriers.
➢ Changes in the economic and political systems of many countries internationally
have created new markets for investment.
➢ FDI allows for closer proximity to international consumers, access to new
technologies, factor endowments, cheap labour, affordable resources, and more efficient
production.

Why Choose FDI? This question is significant considering the number of FDI alternatives
available and the comparatively higher expenses and risks associated with FDI.

Limitations of Exporting
➢ Transportation costs and trade barriers constrain exporting. When transportation costs are
combined with production costs, shipping some products over a considerable distance
becomes unprofitable. Exporting: Manufacturing goods and services domestically, afterwards
selling them to consumers and vendors in foreign countries.
Ex. Products with a low-value-to-weight ratio (cement, soft drinks) are typically
produced domestically, while products with a high-value-to-weight ratio (smartphones,
computer software) are typically produced according to the most efficient
manufacturing locations. This is because transport costs are usually a minor
component of total landed costs in products with a high-value-to-weight ratio.

Licensing: A business agreement between two companies in which the licensor gives the
licensee permission to manufacture a good or service in return for a specified payment.
 Ex. In the late 1990s, Starbucks opened stores in China, Singapore, Thailand, New
Zealand, South Korea, and Malaysia. In Asia, Starbucks’ most common strategy was to license
its format to a local operator in return for initial licensing fees and royalties on

Limitations of Licensing
Licensing has 3 significant drawbacks as a strategy for developing foreign market opportunities.
1. Licensing may result in a firm given valuable technological know-how
to a potential foreign competitor.
2. Licensing does not give a firm tight control over manufacturing,
marketing and strategy.
3. The problem with licensing arises when the firm’s competitive
advantage is based on the products management, marketing and
manufacturing rather than the product itself.
How Political Ideology Affects FDI
Government policy toward FDI has typically been driven by political ideology. Historically,
ideology toward FDI has ranged from a radical stance that is hostile to all to the non-
interventionist principle of free market economics.
Radical stance:
➢ Argues that multinational enterprises (MNEs) are instruments of imperial domination.
➢ Views MNEs as a tool for exploiting host countries.
➢ Argues that MNEs extract profits from host countries, returning profits to home countries.
Since the end of the 1980s, the radical stance has become less common due to the collapse of
communism in Eastern Europe, the generally poor performance of economically restricted
countries and the strong performance of developing countries that have embraced free market
economics (i.e., Singapore).

Free market stance:

➢ Argues that production should be distributed globally according to the theory of
comparative advantage. While no country has fully adopted the free market stance, this
ideology has been embraced by many developed and developing nations like Australia, Ireland,
and Switzerland. Ex. If Ford moves the assembly of some of its cars to Mexico to take advantage
of cheaper labour costs...
 o Ford is freeing up resources in the US, which could then be used in activities in which
the US has a comparative advantage.
o Ford is also transferring technology, skills, and capital to Mexico.

Pragmatic nationalism stance:

➢ Argues that countries should neither adopt a completely free market stance nor a radical
stance.
➢ Argues that while FDI can benefit a host country, the benefits often come with a cost. In
practice, many countries have adopted neither a radical nor a free market policy toward FDI,
but instead a pragmatic nationalism stance.
FDI should only be permitted when benefits > costs.

Impact of FDI on Home Country

Home Country Benefits Home Country Costs
Pros:
➢ Positive effect on the national capital account due to the inward flow of earnings.
➢ Home country of the MNE will be able to learn skills and technologies transferable for use
in the home country.
➢ Positive employment effects occur when a subsidiary demands home country exports of
capital equipment.
Cons:
➢ FDI replaces home country production, eliminating jobs.

Benefits of FDI on Home Country

Balance of payments: The difference between the inflow and outflow of money in a country.

FDI increases the balance of payments in the source country because of the inward flow of
foreign earnings.
Increases also occur when foreign subsidiaries create demand for source country exports of
capital equipment, intermediate goods, and complementary products.
FDI allows firms to learn valuable skills in the host nation that can then be transferred back to
the home country and different subsidiaries internationally.
Ex. The American Firms General Motors and Ford invested in Isuzu and Mazda, two
Japanese automobile companies, to learn about their production process.

FDI increases employment when the foreign subsidiary creates demand for home country
exports.
Ex. A Renault-Nissan plant opens in America. Each automobile requires key inputs
from Japan. Therefore, employment increases in Japan to meet the demand to export
critical inputs to America.

Impact of FDI on host country

Pros:
Resource-transfer effects: FDI brings new capital, technology, and management skills, helping
the country to increase its economic growth.
➢ Jobs increase in the host country.
➢ Competition lowers prices and increases efficiency.
Cons:
➢ Foreign subsidiaries have the solid economic power to put local competitors out of business.
➢ There is a perceived loss of national sovereignty and autonomy since MNEs have no
commitments to the host country.

Benefits of FDI on Host Country

FDI can benefit a country by transferring capital, technology, and management skills that help
the host country to increase its economic growth.
Ex. Many less-developed nations must rely on capital and advanced technologies to
stimulate economic growth. While the governments of other countries may not be
privy to providing those resources, MNEs, by their size and financial strength, can also
provide those resources. Local personnel trained to occupy the posts of foreign
subsidiaries can positively impact host countries by imparting their skills and expertise
to local firms if they leave the foreign subsidiary.

FDI can increase employment in a host country.

 Direct effects:
A foreign MNE employs host country citizens.
➢ Ex. Toyota employs Cambridge residents.
Indirect effects:
Jobs are created due to the income originating from workers employed by the foreign
MNE.
➢ Ex. Toyota workers’ income is spent locally in grocery stores,
restaurants, housing, etc., creating additional local jobs.
Jobs are created in local suppliers as a result of foreign MNEs.
➢ Ex. Toyota requires car parts which can be supplied locally,
increasing employment for local car part suppliers.

FDI can increase the balance of payments in a host country.

If the outputs from foreign MNEs in host countries can be used instead of importing other
goods or services from foreign nations, the balance of payments in a country increases since
imports are limited. The balance of payments in a host country can also increase due to the
foreign MNE exporting the goods and services it produces in the host country.
Ex. A Ford plant in Québec creates cars which are sold across Canada. As a result,
imports of Ford cars from the United States decreased, positively affecting the balance
of payments in Canada. Ex. The Ford plant in Québec also exports its cars to Mexico
and France, raising the balance of payments in Canada.
FDI can increase competition and economic growth in a host country.

When FDI is in the form of a greenfield investment, competition will increase in the local
market. This benefits consumers by driving down prices and offering a more comprehensive
array of options on the market.
More local competition also increases productivity and innovation. As a result,
economic growth occurs.

Ex. In South Korea, FDI by large Western discount stores such as Wal-Mart, Costco,
and Tesco have encouraged indigenous discounter stores to improve the efficiency of
their operations. As a result, South Korean consumers benefited from lower prices and
more excellent choices.
How can the Government Encourage FDI?
Home Country?
➢ Government-backed insurance programs to cover the primary forms of risks associated with
foreign direct investment.
o Ex. Export Development Canada
Host Country
➢ Offer incentives to foreign firms, such as tax breaks and subsidies.
o to attract more FDI.

How can the Government Restrict FDI?

Home Country Host Country
➢ Limit capital outflows.
o Ex. Preventing the exchange of foreign currency.
➢ Manipulate tax laws.
o Ex. Tax foreign earnings at a higher rate.
➢ Prohibit FDI.
o Ex. Prohibit FDI in certain countries with opposing political ideologies.
➢ Use ownership restraints.
o Ex. Limit the shares a foreign owner can hold in a subsidiary.
➢ Use performance requirements.
o Ex. Controls to influence the MNE’s local subsidiary behaviour, such as local content
requirements and local participation in top management.

FDI Implications for Managers

➢A host government’s attitude toward FDI is essential in locating foreign production
facilities. Governments less hospitable towards FDI may choose to restrict FDI.
➢Managers need to consider the implications of trade theory on FDI and the link between
government policy and FDI.
➢The direction of FDI can be explained through the location-specific advantages.