FOREIGN DIRECT INVESTMENT

PROF. MURALI KRISHNAMURTHY

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 OUT LINE
 Definitions.
Theories of FDI.
Forms of FDI.
Strategies of FDI
Cost Benefits of
FDI
Conclusion.
Reference.

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 DEFINING
FDI
Is a process where by residents of one country(source
country) acquire ownership of assets for the purpose
of controlling the production and distributionand
other activities.
IMF’s Balance of Payment manual defines FDI as an
investment that is made to acquire lasting interest in
an enterprise operating in an economy other than that of
an investor, the investor’s purpose beingto have voice in
the management of the enterprise.
The United Nations(1999)World Investment
Report(UNICTAD)defines FDI as an investment having
involving long term relationship and reflecting a lasting
interest and control of resident entity in one economy
in an enterprise resident in an economy
other than that of the foreign direct investor.
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 Cont
…

United States Department of Commerce regards a

foreign business as US foreign affiliate if a US
single investor owns at
least 10 percent of the voting securities.
The distinguishing feature of FDI in comparison
with other forms of international investments is the
element of control over the management policy and
decision. Razin(1999).

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 THEORIES OF FDI
Mac Dougall-Kemp Hypothesis.
FDI moves from capital abundant economy to capital
scarce economy till the marginal production is equal
in both countries. This leads to improvement in
efficiency in utilization of resources in which leads to
ultimate increase in welfare .
According to this theory, foreing direct investment is a
result of differences in capital abundance between
economies. This theory was developed by
MacDougal(1958) and was later elaborated by
Kemp(1964)
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 THEORIES OF FDI
Industrial Organization Theory
According to this theory, MNC with superior technology
moves to different countries to supply innovated
products making in turn ample gains .
Krugman (1989) points out that it was technological
advantage possessed by European countries which led
to massive investment in USA . According to this
theory, technological superiority is the main driving
force for foreign direct investment rather that capital
abundance.

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 THEORIES OF FDI
Currency Based Approaches
A firm moves from strong currency country to weak
currency country. Aliber(1971)postulates that firms from
strong currency countries move out to weak currency
countries.
Froot and Stain(1989)holds that, depreciation in real value of
currency of a country lowers the wealth of a domestic
residents vis- a-vis the wealth of the foreign residents
,thus being cheaper for foreign firms to acquire assets
in such countries. Therefore, foreign direct investments
will move from countries with strong currencies to those
with weak or depreciating currencies.

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 THEORIES OF FDI
Location –Specific Theory
Hood and Young(1979) stress on the location factor.
According to them, FDI moves to a countries with
abundant raw materials and cheap labor force. Since
real wage cost varies among countries, firms with low-
cost technology move to low wage countries.
Abundance of raw materials and cheap labour force are
the main factors for FDI.Countries with cheap labor
and abundant raw material will tend to attract FDI.

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 THEORIES OF FDI
Product Cycle Theory
FDI takes place only when the product in question
achieve specific stage in its life cycle(Vernon
1966)introduction ,growth, maturity and decline stage.
At maturity stage, the demand for new product in
developed countries grow substantially and rival
firms begin to emerge producing similar products at
lower price.
So in order to compete with rivals, innovators decide
to set up production in the host country so as to
beat up the cost of transportation and tariffs.

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 THEORIES OF FDI

Political –Economic Theories

They concentrate on the political risks. Political
stability in the host country leads to FDI(Fatehi-
Sedah and Safizeha 1989). Similarly, political
instability in the home country encourages FDI in
other countries(Tallman 1988).

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 FORMS OF FDI
It takes broadly three forms:
1.Green Field Investment
2.Merger and Acquisitions(M&A)
3.Brown Field Investment.

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 FORMS OF FDI

1.Green Field Investment.

IT is done through opening branches in host countries
or through making investment in the equity capitalof
the host country firm.(Financial collaboration)
If the parent hosts the entire equity of the host
country firm, the late is called wholly owned
subsidiary of the of the parent.
If it is more than half, it is known as subsidiary.
otherwise, it is simply an affiliate.

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 FORMS OF FDI

2.Merger and Acquisition(M&A)

They are either purchase of a running company abroad
or an Amalgamation with a running foreign
company.
For the case of Merger, the acquiring company maintains
its existence and the target company looses its
existence.
For the case of Amalgamation, both loose their
existence in the favor of a new company.
Merger and Acquisition are either Horizontal
13 or Vertical
 FORMS OF FDI
Horizontal Conglomerate is when two or more firms
engaged in similar activities combine.
Vertical is when two firms involved in different
stages of production of a single final
product combine--e.g. Oil exploration with a
refining
Brown Field
Is a combination of Green field and M&A and
then make huge investment for replacing plant
and machinery in the target company.

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 Strategy for
FDI
Firm-Specific Strategy.
It means offering new kind of product or differentiated
product. When product innovation fails to work, a firm
may adopt product differentiation strategy. This is done
through putting trade mark on the product or branding.
Sometimes a firm may adopt different brands for different
markets to make them suitable for local markets. Bata for
example, operates in 92 countries under the same trade
mark, while Uniliver’s low - leather fabric washing product
is marketed is market under five different brands in
Western Europe.
Cost –Economic Strategy.
This strategy is done through lowering cost by moving the
firm to the places where there are cheap factors of
production(eg.labour and raw materials).The cheapness of
these factors of production reduces the cost of production
and maintains an edge over other firms.
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 Cost and Benefits of FDI
Benefits to The Host Country.
1.Availability of scarce factors of production
2. Improvement in Balance of Payments through export
and import substitution.
3.Building of economic and social infrastructure.
4.Fostering of economic linkages.
5. Strengthening of the government budget.
6. Stimulation of national economy. Subsidiaries of
Trans-National Corporations (TNCs), which bring the
vast portion of FDI, are estimated to produce around
a third of total global exports (UNCTAD 1999).
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 Cost and Benefits of FDI

Benefits to The Home Country.

1.Availability of raw material.
2.Improvement in Balance of Payments.
3.Revenue to the government
4.Employement generation
5.Improved political relations.

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 Cost and Benefits of FDI

Cost to the Home Country.

1.Cultural and political interference.
2.Un healthy competition
3. Over utilization of local
resources(both natural and
human resources)
4. Vilation of human rights(child labor eg. the case
of NIKE in Vietnam).
5.Threat to indigenous technology.
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6.Threat to local products.
 Cost and Benefits of FDI

Cost to the Home Country.

It is little compared to the host country.
1.Investment abroad takes away
employment
opportunities.
2. It takes away capital.
3. Out flow of factors of production.

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