Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI)

• FDI signifies an ownership stake in a foreign entity by an investor, company, or government.
• FDI can involve acquiring resources, expanding operations, or establishing a multinational presence.

Types of FDI

• Horizontal FDI occurs when a company establishes the same business operation in a foreign country.
• Vertical FDI involves a business acquiring a complementary business in another country.
• Conglomerate FDI occurs when a company invests in a foreign business unrelated to its core operations.

FDI Trends in the World Economy

• FDI growth lagging behind GDP and trade growth can signal a shift in the global economy.
• The expansion of the service sector benefits larger developing economies, potentially disadvantaging smaller ones.
• Geopolitical tensions disrupt investment patterns, leading to unstable relationships and limited strategic diversification.
• FDI in environmental technologies has surged, becoming the fastest-growing sector, influencing countries to reject investments for environmental compliance.
• Less-developed countries increasingly face marginalization due to global investment flows favoring developed and major emerging markets.

Theories of FDI

• The Production Cycle Theory, developed by Raymond Vernon says Companies initially invest in foreign markets as a product matures and becomes standardized.
• There are four stages in the Production Cycle Theory which are: Innovation, Growth, Maturity and Decline
• The Exchange Rate Theory suggests FDI is influenced by currency strength differences between countries.
• Companies invest in countries with weaker currencies to gain from currency fluctuations and lower costs.
• The Internalization Theory states firms prefer FDI to licensing or exporting to leverage unique competitive advantages.
• Reasons for FDI include Market Imperfections and Internalization Costs
• The Eclectic Paradigm (OLI Framework) combines three factors that influence FDI decisions.
• Ownership Advantage: Unique assets that give firms an edge.
• Location Advantage: Access to resources in foreign locations.
• Internalization Advantages: Better control through FDI than outsourcing.

Political Ideology and FDI

• Free Market Ideologies see FDI as positive for economic growth, embracing open markets, minimal regulation, and investor protection.
• Radical Views, often linked to socialist or communist perspectives, view FDI as exploitation by foreign powers.
• Pragmatic Nationalism seeks to balance FDI benefits with national interests, encouraging FDI while protecting domestic industries.

Costs and Benefits of FDI

• Home Country: The location of the company's headquarters.
• FDI Benefits: Access to cheaper resources, lower production costs, larger customer base, and increased domestic firm efficiency.
• Risk of strategic technology and intellectual property outflow to host countries.
• Host Country: Where the company establishes a presence outside its home country.
• FDI Benefits: Job creation, economic growth through capital, technology transfer, access to international markets, and improved business practices.

Policy Instruments Influencing FDI

• Financial Incentives: Host countries offer tax incentives and loans, while home governments provide insurance and tax breaks.
• Infrastructure: Host governments improve local infrastructure to attract industries.
• Streamlining Administrative Processes & Regulatory Environment reduces bureaucracy to facilitate operations.
• Investing in Education enhances workforce skills to attract global businesses.
• Political, Economic, and Legal Stability: Host countries ensure stable, transparent operating conditions.

Implications for Management

• The World Trade Organization in 1995 changed the governance of FDI.
• The World Trade Organization (WTO) promoted liberalization.
• Dunning's Eclectic Paradigm (OLI Framework) explains FDI direction.
• The Internalization Theory explains FDI preference over licensing or exporting.
• Exporting is favored when transportation costs and trade barriers are low.
• Licensing is unattractive when proprietary property cannot be protected, tight control is needed, or firms skills are amenable to licensing
• A firm's bargaining power with a host government is strongest when the host government values the firm's offer, few alternatives are available, and the firm has time to negotiate.

Regional Economic Integration

• Aims to unify neighboring economies by reducing trade barriers and coordinating monetary and fiscal policies.

Regional Economic Integration Levels

• Free Trade: Promotes economic efficiencies by developing economies of scale and comparative advantages.
• Custom Union: Levels the playing field and addresses re-exports
• Common Market: Allows free movement of services and capital, expanding scale economies
• Economic Union (Single Market): Removes tariffs, creating a uniform market
• Political Union: Integration with a common government

Arguments for Regional Economic Integration.

• Economic: Market, expansion and efficiency, investment attraction and economic growth convergence
• Political: Enhance political stability, collective bargaining and promotion of shared values

History and Scope of Regional Economic Agreements

• Political Arguments: A treaty signed by two or more countries to encourage movement of goods and services across borders
• Agreements have risen since 1990, from fewer than 50 to over 350
• Agreements have evolved from trade barriers to competition policy and intellectual property

Important Regional Agreements

• The European Union (EU)
• North American Free Trade Agreement (NAFTA)
• Asia-Pacific Economic Cooperation (APEC)
• Regional Comprehensive Economic Partnership (RCEP)
• Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)