THEORIES OF FDI- THE IMPACT OF

FDI ON THE HOST (RECIPIENT)

COUNTRY
 FOREIGN DIRECT INVESTMENT
• Foreign Direct Investment (FDI) is an investment made by a firm or individual in one country into
business interests located in another country. generally, fdi takes place when an investor establishes
foreign business operations or acquires foreign business assets, including establishing ownership or
controlling interest in a foreign company. foreign direct investments are distinguished from portfolio
investments in which an investor merely purchases equities of foreign-based companies.
 FDI.......

• FOREIGN DIRECT INVESTMENTS ARE COMMONLY MADE IN OPEN ECONOMIES THAT OFFER A
SKILLED WORKFORCE AND ABOVE-AVERAGE GROWTH PROSPECTS FOR THE INVESTOR, AS
OPPOSED TO TIGHTLY REGULATED ECONOMIES. FOREIGN DIRECT INVESTMENT FREQUENTLY
INVOLVES MORE THAN JUST A CAPITAL INVESTMENT. IT MAY INCLUDE PROVISIONS OF
MANAGEMENT OR TECHNOLOGY AS WELL. THE KEY FEATURE OF FOREIGN DIRECT
INVESTMENT IS THAT IT ESTABLISHES EITHER EFFECTIVE CONTROL OF, OR AT LEAST
SUBSTANTIAL INFLUENCE OVER, THE DECISION-MAKING OF A FOREIGN BUSINESS.
 CHARACTERISTICS OF FDI
• FDI can occur without movement of funds instead it contains package of assets like
equity capital, technology, management and marketing skill, etc.
• The MNES directly control the firms in which FDI’s are made while the firms
offering credit or subscribing portfolio capital in another firms will not control the
latter.
• FDI normally originates from the select oligopolistic industries of the certain(home)
countries and flows into the same industries belonging to the other countries(host).
• The global operations of most of the mnes are not geographically diversified.
• The quality of fdi differ due to the differing motives of mne’s cross-border
operation, divergence in the competence and scope of fcfs, strategies and scope
of mne operations and differences in the nature of firm-specific assets
accessed/possessed by the fcfs.
 CHARACTERISTICS OF FDI

• The MNE’s are more attracted towards industries with four characteristics:
• notably, high levels of r&d relative to sales
• large share of professional and technical workers in their work forces
• products that are new and /or technically complex
• products with high levels of differentiations created through advertising &
marketing.
 THEORIES OF FDI

• INDUSTRIAL ORGANIZATION THEORY

• TRANSACTION COST (OR) INTERNALISATION THEORY OF FDI
• ECLECTIC THEORY OF INTERNATIONAL PRODUCTION
• RESOURCE-BASED VIEW OF FIRM
• FDI BASED ON MONOPOLISTIC POWER
 INDUSTRIAL ORGANIZATION THEORY
• THE INDUSTRIAL ORGANIZATION THEORY IS BASED ON AN OLIGOPOLISTIC OR IMPERFECT
MARKETS IN WHICH THE INVESTING FIRM OPERATES.

• MARKET IMPERFECTIONS ARISE IN MANY CASES, SUCH AS PRDUCT DIFFERENTIATION,

MARKETING SKILLS, PROPRIETARY TECHNOLOGY, MANAGERIAL SKILLS, BETTER ACCESS TO
CAPITAL, ECONOMIES OF SCALE, GOVERNMENT IMPOSED MARKET DISORDER.

• IO THEORY OF FDI UNDERLINES TO TWO MAJOR FACTORS:

• RELATES TO THE CHIEF MOTIVE OF AN OLIGOPOLISTIC FIRM TO OVERCOME COMPETITION TO
ELIMINATE CONFLICTS.
• RELATES TO POSSESSION OF MONOPOLISTIC ADVANTAGE BY THE PROSPECTIVE FOREIGN
INVESTOR THAT OVERCOMES THE DISADVANTAGES OF DOING BUSINESS ABROAD.
 INDUSTRIAL ORGANIZATION THEORY
• SOURCES OF LIABILITY OF FOREIGNNESS ARE CATEGORIZED INTO FOUR MAJOR GROUPS:
• TRANSPORT & COMMUNICATION COST
• LACK OF BUSINESS NETWORKS
• DIFFERENTIAL TREATMENT OF DOMESTIC FIRMS IN COMPARISON TO FOREIGN FIRMS
• RESTRICTIONS IMPOSED BY HOME COUNTRY GOVERNMENT TO SHARE RESOUCES

• MONOPOLOSTIC ADVANTAGE THAT COULD COMPENSATE FOR LIABILITY OF FOREIGNNESS

INCLUDES:
• PRODUCTION AT LOWER PRICES THAN RIVAL FIRMS
• POSSESSION OF SUPERIOR PRODUCTION TECHNOLOGY
• COMMAND OVER BETTER DISTRIBUTION CHANNEL
• SUPER ORGANIZATION & MARKETING SKILLS
TRANSACTION COST (OR) INTERNALISATION THEORY OF FDI
• IN 2003, BUCLEY & CASSON FOCUSED ON THE INTERNATIONAL INVESTMENT THEORY FROM
COUNTRY-SPECIFIC TOWARDS INDUSTRY-LEVEL AND FIRM-LEVEL DETERMINANTS STRESSED THIS
FACT WITH REGARD TO THE CREATION OF MNCS.
• THIS THEORY WAS ARTICULATED BASED ON THREE POSTULATES:
• FIRMS MAXIMIZE PROFITS IN A MARKET THAT IS IMPERFECT;
• WHEN MARKETS IN INTERMEDIATE PRODUCTS ARE IMPERFECT, THERE IS AN INCENTIVE TO BYPASS
THEM BY CREATING INTERNAL MARKETS
• INTERNALIZATION OF MARKETS ACROSS THE WORLD LEADS TO MNCS.
• A FIRM THAT IS ENGAGED IN RESEARCH AND DEVELOPMENT MAY DEVELOP A NEW
TECHNOLOGY OR PROCESS, OR INPUTS. IT MAY BE DIFFICULT TO TRANSFER TECHNOLOGY OR
SELL THE INPUTS TO OTHER UNRELATED FIRMS BECAUSE THOSE OTHER FIRMS MAY FIND THE
TRANSACTION COSTS TO BE TOO HIGH
• IN SUCH SITUATION, A FIRM MAY CHOOSE TO INTERNALIZE BY USING BACKWARD AND FORWARD
INTEGRATION, I.E., THE OUTPUT OF ONE SUBSIDIARY CAN BE USED AS AN INPUT TO THE
PRODUCTION OF ANOTHER, OR TECHNOLOGY DEVELOPED BY ONE SUBSIDIARY MAY BE UTILIZED IN
OTHERS.
TRANSACTION COST (OR) INTERNALISATION THEORY OF FDI
• THIS THEORY IDENTIFIES FIVE TYPES OF MARKET IMPERFECTIONS THAT RESULT IN INTERNALIZATION:
• THE CO-ORDINATION OF RESOURCES REQUIRES A LONG TIME LAG
• THE EFFICIENT EXPLOITATION OF MARKET POWER REQUIRES DISCRIMINATORY PRICING
• A BILATERAL MONOPOLY PRODUCES UNSTABLE BARGAINING SITUATIONS
• A BUYER CANNOT CORRECTLY ESTIMATE THE PRICE OF THE GOODS ON SALE
• GOVERNMENT INTERVENTIONS IN INTERNATIONAL MARKETS CREATES AN INCENTIVE FOR TRANSFER
PRICING.

• ALTHOUGH BUCKLEY & CASSON ACKNOWLEDGED THE RISK OF HOST GOVERNMENT

INTERVENTION, THEY DID NOT CONSIDER THE DIFFERENCE IN THE MAGNITUDE OF THIS RISK
ACROSS VARIOUS INDUSTRIES.
• EG: INDUSTRIES SUCH AS POWER GENERATION AND TELECOMMUNICATIONS MAY FACE A GREATER RISK
OF GOVERNMENT INTERVENTION BECAUSE SOCIETAL CONSIDERATIONS MAY REQUIRE THE BALANCING
OF PRIVATE OBJECTIVES WITH SOCIAL OBJECTIVES.
 ECLECTIC THEORY OF INTERNATIONAL PRODUCTION
• JOHN DUNNING PROPOSED AN ECLECTIC THEORY OR PARADIGM OF FDI IN 1980 AND IN
2000 SUBSTANTIALLY UPDATED THE ECLECTIC THEORY IN A PAPER TITLED "THE ECLECTIC
PARADIGM AS AN ENVELOPE FOR ECONOMIC AND BUSINESS THEORIES OF MNE ACTIVITY".

• GEOGRAPHY AND INDUSTRIAL COMPOSITION OF FDI UNDERTAKEN BY MNES DEPENDS ON

THE CONFIGURATION OF THREE SETS OF ADVANTAGES:
• NET COMPETITIVE ADVANTAGE

• LOCATIONAL ADVANTAGE

• INTERNALISATION ADVANTAGE
 ECLECTIC THEORY - NET COMPETITIVE ADVANTAGE
• DUNNING (2000) CATEGORIZES THE NET COMPETITIVE ADVANTAGES INTO THREE GROUPS:

• THE FIRST ONE RELATES TO THE POSSESSION AND EXPLOITATION OF MONOPOLISTIC ADVANTAGES WHICH ARISE
FROM (OR CREATE) BARRIERS TO ENTRY TO FINAL PRODUCT MARKETS FOR FIRMS NOT POSSESSING THEM.

• THE SECOND ONE STEMS FROM THE OWNERSHIP OF A BUNDLE OF SCARCE, UNIQUE AND SUSTAINABLE RESOURCES
AND CAPABILITIES AS IDENTIFIED BY THE RBV.

• THE THIRD ONE COMES FROM THE ORGANIZATION THEORY OF MNES AND INCLUDES "THE COMPETENCIES OF THE
FIRMS TO IDENTIFY, EVALUATE AND HARNESS RESOURCES AND CAPABILITIES FROM THROUGHOUT THE WORLD AND
TO COORDINATE THESE WITH THE EXISTING RESOURCES AND CAPABILITIES UNDER THEIR JURISDICTION IN A WAY
WHICH BEST ADVANCES THE LONG TERM INTEREST OF THE FIRMS”.

• THE LONG TERM INTEREST OF THE FIRM MAY INCLUDE "MINIMIZING TRANSACTION COSTS AND MAXIMIZING THE
BENEFITS OF INNOVATIONS, LEARNING AND ACCUMULATED KNOWLEDGE".
 ECLECTIC THEORY - NET COMPETITIVE ADVANTAGE
• THE MULTINATIONALITY (I.E. THE EXTENT TO WHICH A FIRM UNDERTAKES VALUE-ADDING ACTIVITIES IN MANY
DIFFERENT FOREIGN COUNTRIES) PER SE HAS ALSO BECOME AN IMPORTANT INTANGIBLE ASSET.

• THE ADVANTAGE OF MULTINATIONALITY DUE TO OPERATION IN MANY DIVERSE COUNTRIES MAY INCLUDE:

• ECONOMIES OF SCALE ARISING FROM SPREADING OF FIXED COSTS OVER A LARGER MARKET;

• LOWERING OF RISK STEMMING FROM THE CHANGE IN A COUNTRY'S INTEREST RATES, WAGE RATES, AND COMMODITY AND
RAW MATERIAL PRICES;

• ACCESSING TO CHEAPER AND IDIOSYNCRATIC RESOURCES AVAILABLE IN VARIOUS COUNTRIES SUCH AS THE CHEAPER LABOUR,
BETTER TECHNOLOGY, OR ANY COUNTRY-SPECIFIC RESOURCES;

• GLOBAL OPPORTUNITIES FOR ORGANIZATIONAL LEARNING OR EXPERIENCE AND FOR SCANNING RIVALS, MARKETS AND
PROFITABLE VENTURES.
 ECLECTIC THEORY – LOCATIONAL ADVANTAGE
• THE ECLECTIC PARADIGM RECOGNIZES THE LOCATIONAL ADVANTAGES OR THE ATTRACTIVENESS OF THE COUNTRIES AS THE
KEY DETERMINANTS OF FOREIGN PRODUCTION BY MNES.

• THE LOCATION-SPECIFIC ADVANTAGES OF A COUNTRY MAY INCLUDE CHEAPER AVAILABILITY OF FACTOR ENDOWMENTS LIKE
NATURAL RESOURCES, LABOUR, RAW MATERIAL; LARGE DOMESTIC MARKET, LOWER TRANSPORT AND COMMUNICATION
COST; BETTER PHYSICAL INFRASTRUCTURE.

• PROVIDED THAT A FIRM HAS UNIQUE OWNERSHIP OR COMPETITIVE ADVANTAGES, IT MUST BE PROFITABLE FOR THE FIRM TO
UTILISE THESE ADVANTAGES IN COMBINATION WITH LOCATION SPECIFIC ADVANTAGES EXISTING IN A FOREIGN COUNTRY,
OTHERWISE, THE FOREIGN MARKETS WOULD BE SERVED BY EXPORTS.

• THE GREATER THE NET OWNERSHIP ADVANTAGE OF THE FIRMS (NET OF ANY DISADVANTAGES OF OPERATING IN A FOREIGN
LOCATION), THE MORE THE INCENTIVE THEY HAVE TO UTILIZE THESE ADVANTAGES AMONG THEMSELVES.

• THUS, A FIRM'S PROPENSITY TO ENGAGE IN FOREIGN PRODUCTION IS JOINTLY DETERMINED BY THE COUNTRY'S LOCATIONAL
ADVANTAGES OF IMMOBILE NATURAL RESOURCES OR CREATED ASSETS AND ITS OWN OWNERSHIP OR COMPETITIVE
ADVANTAGES.
 ECLECTIC THEORY – INTERNALIZATION ADVANTAGE
• A FIRM HAS A SET OF COMPETITIVE OR OWNERSHIP-SPECIFIC ADVANTAGES AND THE IMMOBILE LOCATIONAL
ADVANTAGES OF A FOREIGN COUNTRY ARE SUCH AS TO WARRANT LOCATING VALUE ADDING OR ASSET
AUGMENTING ACTIVITIES.

• THE FIRMS NOT ONLY TRY TO MAXIMIZE PROFITS BY OPTIMIZING THE USE OF EXISTING ASSETS INTERNALLY THROUGH
THEIR FOREIGN AFFILIATES BUT THEY ALSO UNDERTAKE FDI, AS IN MANY CASES OF CROSS-BORDER MERGERS AND
ACQUISITIONS, TO ACQUIRE NEW RESOURCES AND CAPABILITIES, OR TO ACQUIRE NEW MARKETS, OR TO ACHIEVE
LOWER UNIT COSTS OF PRODUCTION, OR TO GAIN MARKET POWER, OR TO FORESTALL OR THWART THE
COMPETITIONS.
ECLECTIC THEORY OF INTERNATIONAL PRODUCTION
• The eclectic paradigm further avers that the significance of each of these three advantages, the
precise configuration of these advantages applicable to a firm and the response of the firm to
that configuration are likely to be the context specific.
• The context specific factors include the following:
• The economic and political features of the country (or the regions) of the investing firms and the
countries (or the regions) hosting fdi.
• The nature of industry and the types of value-added activities in which the firms are engaged.
• The characteristics of the individual investing firms, including their objectives and strategies in pursuing
these objectives.
• The four motives of the fdi, namely, natural resources seeking, market seeking, efficiency seeking and
strategic asset seeking.
• THE EXTENT OF MARKET FAILURE INFLUENCING WHETHER OR NOT THE MARKET FOR TECHNOLOGY
IS INTERNALIZED ACROSS DIFFERENT INDUSTRIES.
• DIFFERENCES IN THE PERCEPTIONS OF DIFFERENT CORPORATIONS ABOUT THE COMPARATIVE
LOCATIONAL ADVANTAGES OF DIFFERENT COUNTRIES AS A MANUFACTURING BASE.
 RESOURCE-BASED VIEW OF FIRM
• With this theory in1990s, the focus regarding sources of sustainable competitive advantage and
firm level performance (efficiency/profitability) has shifted from industry structure and firms'
conducts to the quantity and nature of resources possessed of the firms within an industry.

• The researchers look for possible causes of sustainable competitive advantage mostly within the
resources and capabilities of a firm, holding constant all external environmental factors.

• The RBV divides resources into two major heads, namely tangible resources and intangible
resources or assets.
• THE TANGIBLE RESOURCES INCLUDE FINANCIAL, PHYSICAL AND HUMAN CAPITAL. THESE RESOURCES
POSSESS FIXED LONG-RUN CAPACITY AND PROPERTIES OF OWNERSHIP AND ARE RELATIVELY EASY
TO BE MEASURED, TRADED AND DUPLICATED.
 RESOURCE-BASED VIEW OF FIRM
• INTANGIBLE RESOURCES CONSIST OF INTELLECTUAL PROPERTY RIGHTS, CONTRACTS,
ORGANIZATIONAL AND MARKETING EXPERTISE, TRADE SECRETS, REPUTATION OR GOODWILL AND
NETWORKS WITH CUSTOMERS, SUPPLIERS, GOVERNMENT ORGANIZATIONS, RESEARCH INSTITUTES.

• IN COMPARISON TO TANGIBLE RESOURCES, INTANGIBLE ASSETS DO NOT DIMINISH BY EXTRA

USE; THEY ARE RELATIVELY RESISTANT TO DUPLICATION AND DIFFICULT TO BE MEASURED,
VALUED AND TRADED.
• THUS, THE INTANGIBLE RESOURCES ARE MORE IMPORTANT SOURCE OF HETEROGENEITY AND
DIVERGENCE IN COMPETITIVE ADVANTAGE AND PERFORMANCE ACROSS FIRMS.
• THE RBV PROVIDES AN EFFICIENCY BASED EXPLANATION OF PERFORMANCE.
• PETERAF AND BARNEY (2003) SUGGEST THAT A FIRM BUILDS COMPETITIVE ADVANTAGE ONLY
THROUGH EFFICIENCY OR EFFECTIVENESS IN USE OF IT RESOURCES, I.E., BY PRODUCING MORE
ECONOMICALLY FROM THE SET OF RESOURCES IT HOLDS AND BY DELIVERING GREATER
BENEFITS TO ITS CUSTOMERS AT A GIVEN COST (OR THE SAME BENEFITS AT A LOWER COST).
 RESOURCE-BASED VIEW OF FIRM
• RBV IS BASED ON TWO MAJOR ASSUMPTIONS:

• FIRST, FIRMS ARE FUNDAMENTALLY HETEROGENEOUS IN TERMS OF THEIR BUNDLE OF

RESOURCES AND CAPABILITIES WITHIN AN INDUSTRY.

• SECOND, RESOURCE HETEROGENEITY MAY PERSIST OVER TIME BECAUSE THE RESOURCES USED
FOR ACQUIRING COMPETITIVE ADVANTAGES ARE RARE, VALUABLE, IMPERFECTLY IMITABLE,
IMPERFECTLY SUBSTITUTABLE AND IMPERFECTLY MOBILE IN STRATEGIC FACTOR MARKETS.

• THE IDENTIFICATION AND EVALUATION OF RESOURCES AND CAPABILITIES HAS BEEN THE
MAJOR CONTRIBUTIONS OF THE RBV.
 FDI BASED ON MONOPOLISTIC POWER
• KINDLEBERGER (1969), BY EXTENDING THE WORK OF HYMER, PUT FORWARD HIS THEORY OF
FDI ON THE BASIS OF MONOPOLISTIC POWER.

• KINDLEBERGER ARGUED THAT ADVANTAGES ENJOYED BY MNCS COULD BE USEFUL ONLY IN

THE CASE OF MARKET IMPERFECTION.

• THE ADVANTAGES DESCRIBED BY HIM MIGHT BE IN THE FORM OF SUPERIOR TECHNOLOGY,

MANAGERIAL EXPERTISE, PATENTS ETC.

• THESE ADVANTAGES GENERALLY ENCOURAGE A FIRM TO INVEST IN A FOREIGN COUNTRY IN

ORDER TO FULLY EXPLOIT THEM INSTEAD OF SHARING THEM WITH POTENTIAL COMPETITORS
IN THE FOREIGN MARKET.
 FDI BASED ON MONOPOLISTIC POWER
• THE GREATER THE CHANCES OF EARNING MONOPOLY PROFITS, THE HIGHER WILL BE THE
ENCOURAGEMENT AMONG FIRMS TO INVEST DIRECTLY.

• KINDLEBERGER DESCRIBED VARIOUS FORMS OF ADVANTAGES GENERALLY ENJOYED BY A FIRM

OVER THE HOST COUNTRY FIRM; HE FAILED TO DESCRIBE WHICH ADVANTAGE A FIRM SHOULD
FOCUS ON.

• A FIRM CAN EXPLOIT ITS MONOPOLISTIC ADVANTAGES ABROAD ONLY IF THE HOST
COUNTRY’S POLICY ALLOWS IT TO DO SO. GENERALLY, IN THE NAME OF NATIONAL INTEREST,
THE HOST GOVERNMENT WOULD BE UNWILLING TO PERMIT FREE ENTRY OF FOREIGN FIRMS
INTO THE COUNTRY.